Notes to the Consolidated Financial Statements

(tabular amounts in millions of 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 (GAAP). A summary of the differences between accounting principles generally accepted in Canada and those generally accepted in the United States of America (US) is presented in note 25.

The Company is in the business of exploration, development, production and marketing of crude oil, natural gas and natural gas liquids (NGL).

a) Consolidation

The Consolidated Financial Statements include the accounts of Talisman and its subsidiaries. Substantially all of Talisman’s activities are conducted jointly with others, and the Consolidated Financial Statements reflect only the Company’s proportionate interest in such activities.

b) Accounts Receivable

Accounts receivable are recorded based on the Company’s revenue recognition policy. The allowance for doubtful accounts is management’s best estimate of accounts receivable balances that may not be collectible, and is reviewed quarterly.

c) Inventories

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

d) Property, Plant and Equipment (PP&E)

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. Exploration well costs are initially capitalized and, if subsequently determined to have not found sufficient reserves to justify commercial production, are charged to dry hole expense. Exploration well costs that have found sufficient reserves to justify commercial production, but which cannot be classified as proved, continue to be capitalized as long as sufficient progress is being made to assess the reserves and economic viability of the well and/or related project. 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 when events occur that indicate the carrying value of properties may not be recoverable from future cash flows. Any impairment loss is the difference between the carrying value of the asset and its fair value. Fair value is calculated as the present value of estimated expected future cash flows from proved, probable and, as appropriate, possible reserves.

Repairs and maintenance costs are charged as an expense when incurred.

Well injection costs incurred to stimulate depleted wells are charged as an expense when incurred. Certain stimulation costs which increase production and reserves, extending beyond one year, are deferred in PP&E as development costs, and depleted using the unit of production method.

e) Depreciation, Depletion and Amortization (DD&A)

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 (bbls) on an energy equivalent basis at a ratio of six thousand cubic feet (mcf) of natural gas for one barrel (bbl) of oil. Depletion rates are updated annually unless there is a material change in circumstances, in which case they would be updated more frequently. Material changes in year-end reserves are reflected in the fourth quarter depletion rate.

Successful exploratory wells and development costs are depleted over proved developed reserves. However, to the extent significant development costs are incurred in connection with proved undeveloped reserves, such costs are excluded from depletion until the reserves are developed. To the extent a property has nil proved reserves, development costs are charged immediately as DD&A expense.

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.

Costs associated with significant development projects are not depleted until the asset is substantially complete and ready for its intended use. Unproved land acquisition costs that are individually material are not amortized, but are assessed for impairment and transferred to depletable costs as proved reserves are recognized. Unproved land acquisition costs that are individually immaterial are amortized on a straight-line basis over the average lease term. 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 4% and 5% to 33%, respectively. Gas plants and pipelines in the United Kingdom (UK) and Scandinavia are depreciated using the unit of production method based on the related fields.

See the discussion concerning ‘Measurement Uncertainty and Use of Estimates’ in note 1(u).

f) Asset Retirement Obligations (ARO)

The fair value of the statutory, contractual or legal liability associated with the retirement and reclamation of tangible long-lived assets is recorded when incurred, with a corresponding increase to the carrying amount of the related assets. The increase to capitalized costs is amortized to net income on a basis consistent with DD&A of the underlying assets. Subsequent changes in the estimated fair value of the ARO are capitalized and amortized over the remaining useful life of the underlying asset.

The ARO liabilities are carried on the Consolidated Balance Sheets at their discounted present value and are accreted over time for the change in their present value, with this accretion charge included in DD&A. Actual expenditures incurred are charged against the accumulated obligation. Any difference between the recorded ARO and the actual retirement costs incurred is recorded as a gain or loss in the settlement period.

g) Capitalized Interest

Interest costs associated with major development projects are capitalized until the necessary facilities are completed and ready for use. These costs are subsequently amortized to income with the related assets.

h) 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 takes, 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.

i) Petroleum Revenue Tax (PRT)

UK PRT is accounted for using the life-of-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.

j) Foreign Currency Translation

Talisman’s functional currency is the US$.

The Company’s self-sustaining operations in the UK (and, prior to January 1, 2010 in Canada and Norway) were translated from UK£, C$ and NOK respectively into US$ using the current rate method whereby assets and liabilities were translated at year-end exchange rates, while revenues and expenses were converted using average rates for the period. Gains and losses on translation to US$ relating to self-sustaining operations were deferred and included in a separate component of shareholders’ equity described as accumulated other comprehensive loss. As a result of a reorganization of the Company’s operations, changes in the composition of revenue and costs and changes in intercompany loan arrangements, management has determined that the functional currency of the Company’s UK, Canada and Norway operations is more closely linked to the US$. Accordingly, effective January 1, 2010 for Canada and Norway and January 1, 2011 for the UK, these operations have been accounted for as US$ functional currency entities. As a result, foreign currency translation adjustments remain in accumulated other comprehensive loss until Talisman reduces its net investment in those subsidiaries. Following the change in the functional currency of the UK operations, the debt denominated in UK£ will no longer be designated as a hedge of Talisman’s net investment in the UK and, accordingly, future foreign exchange gains and losses will be recorded in the Consolidated Statement of Income.

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 C$, with amounts translated to C$ 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 rate for the year. The Company’s share capital accounts, including its 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 C$ reporting currency are included in accumulated other comprehensive loss. Effective from the first quarter of 2011, the Company will be reporting its financial results in US$.

k) Employee Benefit Plans

The cost of pensions and other retirement benefits earned by employees is determined using the projected benefit method pro-rated on service and management’s best estimate of expected plan investment performance, salary escalation and employee retirement ages. 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 cumulative unamortized net actuarial gain or loss over 10% of the greater of the accrued 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 unamortized transitional assets and obligations and past service costs are being amortized over the average remaining service period of active employees expected to receive benefits under the benefit plans.

l) Financial Instruments

Non-hedge financial instruments

The Company classifies its financial instruments into one of the following categories: held-for-trading (assets and liabilities), assets available-for-sale, loans and receivables, assets held-to-maturity and other financial liabilities. All financial assets and liabilities are recognized in the Consolidated Balance Sheet when the Company becomes a party to the contractual requirements of the instrument. All financial instruments are measured at fair value on initial recognition. Transaction costs are included in the initial carrying amount of financial instruments except for held-for-trading items, in which case they are expensed as incurred. Measurement in subsequent periods depends on the classification of the financial instrument.

Financial assets and liabilities held-for-trading are subsequently measured at fair value with changes in fair value recognized in net income. Financial assets available-for-sale are subsequently measured at fair value with changes in fair value recognized in other comprehensive loss, net of tax.

Financial assets held-to-maturity, loans and receivables, and other financial liabilities are subsequently measured at amortized cost using the effective interest rate method.

Cash equivalents are classified as held-for-trading and are measured at carrying value, which approximates fair value due to the short-term nature of these instruments. Accounts receivable and certain other assets that are financial instruments are classified as loans and receivables. Accounts payable and accrued liabilities, other long-term obligations and current and long-term debt are classified as other financial liabilities.

Financial instruments that are derivative contracts are considered held-for-trading unless they are designated as a hedge. The financial derivative contracts outstanding at December 31, 2010 are disclosed in note 15.

Canadian Institute of Chartered Accountants (CICA) handbook section 3855 Financial Instruments – Recognition and Measurement requires that an asset or liability be recognized for certain embedded derivatives by separating them from their host contracts and measuring them at fair value. Talisman has elected the beginning of its fiscal year ended December 31, 2003 as the effective date for embedded derivatives. Consequently, only embedded derivatives in contracts entered into or acquired or substantially modified on or after January 1, 2003 are subject to the separate recognition measurement provisions of this standard.

Hedges

In conducting its business, the Company may use derivative financial instruments in order to manage risks associated with fluctuations in commodity prices, interest rates and foreign currency exchange rates. The Company may designate financial instruments as a hedging instrument for accounting purposes.

Hedge accounting requires the designation of a hedging relationship, including a hedged and a hedging item, identification of the risk exposure being hedged and reasonable assurance that the hedging relationship will be effective throughout its term. In addition, in the case of anticipated transactions, it must also be 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.

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 on the hedge at that date is deferred in other comprehensive loss and recognized in net income concurrently with the anticipated transaction. If it is probable that the transaction designated as being hedged will not occur substantially as and when identified at the inception of the hedging relationship, the gain or loss on the hedge at that date is recognized in net income immediately.

Cash flow hedges – The effective portion of changes in the fair value of financial instruments designated as cash flow hedges is recognized in other comprehensive loss, net of tax, with any ineffective portion being recognized immediately in net income. Gains and losses are recovered from other comprehensive loss and recognized in net income in the same period as the hedged item is realized.

Fair value hedges – Both the financial instrument designated as the hedging item and the portion of the underlying hedged asset or liability attributable to the hedged risk are measured at fair value. Changes in the fair value of the financial instrument designated as the hedging item and changes in the fair value of the hedged item attributable to the hedged risk are reflected in net income immediately.

Net investment hedges – Foreign exchange gains and losses on debt designated as a net investment hedge are recognized in other comprehensive loss. These gains and losses are recovered from other comprehensive loss and recognized in net income if the net investment is reduced.

The Company enters into physical commodity contracts in the normal course of business, including contracts with fixed terms. The natural gas sales contracts outstanding at December 31, 2010 are disclosed in note 16. 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.

m) Comprehensive Income (Loss) and Equity

The Consolidated Statements of Comprehensive Income (Loss) reflect net income and the changes in accumulated other comprehensive loss in the year. Changes in accumulated other comprehensive loss are composed of changes in the fair value of financial instruments designated as hedges, to the extent they are effective, gains and losses recovered from other comprehensive loss and recognized in net income, foreign currency translation gains or losses arising from the translation of the Company’s self-sustaining foreign operations or reductions in the net investments therein and translation from the Company’s functional currency to its presentation currency.

n) 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 and those reported for income tax purposes. 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. The Company recognizes in its financial statements the best estimate of the impact of a tax position by determining if the available evidence indicates whether it is more likely than not, based solely on technical merits, that the position will be sustained on audit. For those tax positions meeting the more-likely-than-not recognition threshold, the Company recognizes the largest amount of tax benefit that is greater than 50% likely of being realized on settlement with the taxing authority.

To the extent that interest and penalties are assessed by taxing authorities on any underpayment of income tax, these amounts have been accrued and are classified as a component of income taxes on the Consolidated Statements of Income.

Certain of the Company’s contractual arrangements in foreign jurisdictions stipulate that income taxes 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.

o) Revenue Recognition

Revenues associated with the sale of crude oil, natural gas and liquids are recognized when title passes from the Company to the customer. For the Company’s international operations, generally, customers take title when the crude oil is loaded onto a tanker. The Company employs the entitlement method in accounting for crude oil and natural gas sales and records a receivable from a joint interest participant if a participant sells more than its proportionate share of crude oil or natural gas production. Crude oil and natural gas produced and sold, below or above the Company’s working interest share in the related resource properties, results in production underliftings, or overliftings. Underliftings are recorded as inventory at the cost to produce and transport the product to storage tanks, and overliftings are recorded in accounts payable and accrued liabilities. Underliftings are reversed from inventory when the crude oil is lifted and sold, with the sales proceeds recorded as revenue and the cost of the inventory expensed. Overliftings are reversed from accounts payable and accrued liabilities when sufficient volumes are produced to make up the overlifted volume. Amounts received under take-or-pay gas sales contracts in respect of undelivered volumes are accounted for as deferred income in accounts payable and accrued liabilities and recognized as revenue when volumes are delivered. Transportation expenses are reported as a separate expense and not netted off against revenue.

A significant portion of the Company’s operations outside North America, the UK and Scandinavia are governed by Production Sharing Contracts (PSCs). Under PSCs, revenues are derived from cost recovery oil and gas and profit oil and gas. Generally, cost recovery oil and gas allows the Company to recover its capital and production costs and, as appropriate, the costs carried by the Company on behalf of national oil companies from production. Profit oil is allocated to the host government and contract parties in accordance with their respective equity interests.

Gross sales as reported represents the Company’s share of revenues from the sale of crude oil, natural gas and liquids and is presented before royalty payments to governments and other mineral interest owners.

All taxes collected from customers that are remitted to governments are excluded from revenues.

p) Leases

Leases that transfer substantially all of the benefits and risks of ownership to Talisman are accounted for as capital leases and recorded as PP&E, together with an offsetting liability. All other leases are accounted for as operating leases and the lease costs are expensed as incurred.

q) Stock-Based Compensation

During 2010, Talisman had stock option plans, cash unit plans, performance share unit (PSU) plans, a deferred share unit plan and a restricted share unit plan, which are described in note 13. The PSU plans must be settled in shares. The cash unit, deferred share unit and restricted share unit plans must be settled in cash. The stock option plans may be settled in cash at the option of the holder and, consequently, they are classified as liability instruments and measured at their intrinsic value less any unvested portion. Unvested options accrue evenly over the vesting period. The intrinsic value is determined as the difference between the market value of the Company’s common shares and the exercise price of the options or units. This obligation is revalued each reporting period and the change in the obligation is recognized as stock based compensation expense (recovery), except for the changes related to deferred share units, which are included in general and administrative expenses. For the PSU plans, the Company determines the fair value of the units on the date of grant using the share price on that date and recognizes the fair value of the units over the vesting period as compensation expense and contributed surplus. Net income is adjusted by reducing the compensation expense in periods containing forfeitures of unvested options and units, and by changes in the degree to which the predetermined performance measures are achieved.

r) Goodwill

Goodwill represents the excess purchase price over the fair value of identifiable assets and liabilities acquired in business combinations. Goodwill is not amortized but is subject to impairment reviews in the fourth quarter of each year, or more frequently as economic events dictate, based on the fair value of the reporting units. The impairment test requires that goodwill be allocated to reporting units. Talisman has determined its reporting units by aggregating components having similar economic characteristics and/or which are in similar geographic locations. These reporting units correspond with the segments described in note 24. 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, a second test is performed to determine the amount of the goodwill 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.

s) Net Income and Diluted Net Income Per Share

Net income per share is calculated by dividing net income 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 stock options were exercised to acquire common shares.

The Company uses the treasury stock method to determine the dilutive impact of stock options. This method assumes that any proceeds from the exercise of in-the-money stock options would be used to purchase common shares at the average market price during the year.

t) Cash and Cash Equivalents

Cash and cash equivalents include cash on deposit with banks and short-term investments with an original maturity of three months or less. Cash and cash equivalents are stated at cost, which approximates market value.

u) Measurement Uncertainty and Use of Estimates

To facilitate the timely preparation of the Consolidated Financial Statements, management has made estimates and assumptions regarding certain assets and liabilities and contingent assets and liabilities at the date of the Consolidated Financial Statements and the reported amounts of revenues and expenses during the year. Such estimates primarily relate to unsettled transactions and events as of the date of the Consolidated Financial Statements. Accordingly, actual results may differ from estimated amounts.

Purchase price allocations, DD&A and amounts used for impairment calculations are based on estimates of oil and natural gas reserves and commodity prices and capital costs required to develop those reserves. By their nature, estimates of reserves and the related future cash flows are subject to measurement uncertainty, and the impact of differences between actual and estimated amounts on the Consolidated Financial Statements of future periods could be material.

Inherent in the fair value calculation of ARO are numerous assumptions and judgments, including the ultimate settlement amounts, inflation factors, credit adjusted discount rates, timing of settlement and changes in the legal, regulatory, environmental and political environments. To the extent future revisions to assumptions impact the fair value of the existing ARO liability, a corresponding adjustment is made to the oil and gas assets balance.

The values of pension assets and obligations and the amount of the net benefit plan expense charged to net income depend on actuarial and economic assumptions which, by their nature, are subject to significant measurement uncertainty.

The measurement of income tax expense, in particular UK PRT, and the related provisions on the Consolidated Balance Sheets, is subject to uncertainty associated with future recoverability of oil and natural gas reserves, commodity prices, the timing of future events, and changes in legislation, tax rates and interpretations by tax authorities.

The fair values of financial instruments are estimated based upon market and third party inputs. These estimates are subject to change with fluctuations in commodity prices, interest rates, foreign currency exchange rates and estimates of non-performance risk.

v) Comparative Information

Certain comparative information provided in the notes to the Consolidated Financial Statements has been reclassified to conform to the presentation adopted in the current year.

2. Changes in Accounting Policies

a) Extractive Activities – Oil and Gas

In the fourth quarter of 2009, Talisman adopted prospectively the US standard Extractive Activities – Oil and Gas whereby yearly average commodity prices are used for purposes of calculating reserves. Previously, reserves had been calculated by reference to year-end commodity prices. Since, 2009 yearly average commodity prices were higher than 2008 year-end prices. Talisman recorded an upward price revision of 77.1 million barrels of oil equivalent (mmboe) to its reserves in the fourth quarter of 2009 and revised its DD&A rates accordingly.

b) Goodwill and Intangible Assets

Effective January 1, 2009, Talisman adopted the CICA recommendations relating to the recognition, measurement and disclosure of Goodwill and Intangible Assets (section 3064). The adoption of these recommendations had no impact on Talisman.

c) Financial Instruments Presentation and Disclosure

In 2009, the CICA revised section 3862 Financial Instruments – Disclosure to include a hierarchy concept in measuring financial instruments, a requirement to provide disclosure concerning the fair value measurements of assets and liabilities for each hierarchy level and amendments to the liquidity disclosure requirements. Since Talisman previously used a hierarchy concept in measuring financial instruments and provided such disclosure in its Consolidated Financial Statements, this amendment had no impact on Talisman.

Effective January 1, 2008, Talisman adopted the CICA recommendations relating to Financial Instruments – Disclosure (section 3862) and Financial Instruments – Presentation (section 3863). The disclosure required by section 3862 concerning the nature and extent of the risks associated with financial instruments, and how those risks are managed, is presented in note 15. As permitted, comparative information for the disclosure required by section 3862 has not been provided. The adoption of section 3863 had no impact on Talisman, since the new standard carried forward the existing presentation requirements.

d) Credit Risk and the Fair Value of Financial Assets and Liabilities

Effective December 31, 2008, Talisman adopted retrospectively the recommendations of Emerging Issues Committee abstract 173 relating to the fair value of financial assets and liabilities, which was issued in January 2009, without restatement of prior periods. The abstract requires that an entity’s own credit risk and the credit risk of the counterparty are taken into account in determining the fair value of financial assets and liabilities, including derivative instruments, for presentation and disclosure purposes. The adoption of the abstract did not have a material impact on Talisman.

e) Inventories

Effective January 1, 2008, Talisman adopted retrospectively the CICA recommendations relating to Inventories (section 3031). The standard provides additional guidance concerning measurement, classification and disclosure and allows the reversal of writedowns to net realizable value when there is a change in the circumstances giving rise to the impairment. On adopting these recommendations, the Company reclassified inventory that is expected to be capitalized when consumed from other assets to PP&E.

3. Discontinued Operations

The assets and liabilities related to discontinued operations have been reclassified as assets or liabilities of discontinued operations on the Consolidated Balance Sheets. Operating results related to these assets and liabilities have been included in income from discontinued operations on the Consolidated Statements of Income. Comparative period balances have been restated.

Income from discontinued operations reported on the Consolidated Statements of Income is composed of the following:

	Years ended December 31
	North America			UK			Scandinavia			Other			Total
	2010	2009	2008	2010	2009	2008	2010	2009	2008	2010	2009	2008	2010	2009	2008
Revenue
Gross sales	305	696	1,548	–	–	134	–	–	46	7	48	231	312	744	1,959
Royalties	35	120	299	–	–	–	–	–	3	1	1	31	36	121	333
Revenue, net of royalties	270	576	1,249	–	–	134	–	–	43	6	47	200	276	623	1,626
Expenses
Operating, marketing and general	77	186	214	–	–	81	–	–	5	4	7	15	81	193	315
Interest	–	–	–	–	–	–	–	–	(2)	–	–	–	–	–	(2)
Dry hole	–	44	59	–	–	–	–	–	–	–	1	2	–	45	61
Depreciation, depletion and amortization	95	354	373	–	–	6	–	–	20	–	6	38	95	360	437
Income (loss) from discontinued operations before taxes	98	(8)	603	–	–	47	–	–	20	2	33	145	100	25	815
Taxes	25	(2)	153	–	–	15	–	(1)	–	3	14	76	28	11	244
Gain (loss) on disposition, net of tax	173	511	119	–	482	4	–	(2)	(54)	(5)	90	–	168	1,081	69
Income (loss) from discontinued operations	246	505	569	–	482	36	–	(1)	(34)	(6)	109	69	240	1,095	640

The assets and liabilities of discontinued operations presented on the Consolidated Balance Sheets are composed of the following:

	At December 31
	North America		UK		Scandinavia		Other		Total
	2010	2009	2010	2009	2010	2009	2010	2009	2010	2009
Assets
Current assets	–	40	–	–	–	–	–	18	–	58
Property, plant and equipment, net	–	2,483	–	–	–	–	–	19	–	2,502
Goodwill	–	62	–	–	–	–	–	3	–	65
Total assets1	–	2,585	–	–	–	–	–	40	–	2,625
Liabilities
Current liabilities	–	9	–	–	–	–	–	–	–	9
Asset retirement obligations	–	65	–	–	–	–	–	1	–	66
Future income taxes	–	123	–	–	–	–	–	5	–	128
Total liabilities1	–	197	–	–	–	–	–	6	–	203

North America

In 2010, Talisman completed the sale of oil and gas producing properties in North America for proceeds of $2 billion, resulting in a gain of $173 million, net of a tax recovery of $105 million. The net investment in the Company’s Canadian self-sustaining operations has been reduced as a result of these disposal transactions and a capital distribution to the parent from the entity that held the assets and, accordingly, $465 million of non-taxable foreign exchange gains previously accumulated in other comprehensive loss were included in the carrying value of the assets used to determine the gain on disposal.

In 2009, Talisman completed the sale of oil and gas producing assets in Western Canada for proceeds of $1.2 billion, resulting in a gain of $456 million, net of tax of $110 million. Talisman also completed the sale of certain of its midstream assets in Western Canada for proceeds of $297 million, resulting in a gain of $55 million, net of tax of $19 million.

In 2008, Talisman completed the sale of gas producing assets in Western Canada for proceeds of $247 million, resulting in a gain of $119 million, net of tax of $40 million.

UK

In 2009, Talisman completed the sale of its assets in the Netherlands for proceeds of $596 million, resulting in a gain of $471 million, net of tax of $nil. Talisman also received $17 million of contingent consideration relating to an agreement entered into in 2007 to sell assets in the UK, resulting in a gain of $11 million, net of tax of $6 million.

In 2008, Talisman completed the sale of oil and gas properties resulting in an after tax writedown of $32 million and recorded a positive after tax closing adjustment of $36 million in respect of oil and gas properties sold in 2007 and 2006.

Scandinavia

In 2009, Talisman completed the sale of a 10% share in the Yme field offshore development and three exploration licences for proceeds of $113 million, resulting in a gain of $6 million, net of tax of $nil. After tax writedowns of $8 million had previously been recorded in each of 2008 and 2009.

In 2008, Talisman completed the sale of assets in Denmark for proceeds of $95 million, resulting in an after tax writedown of these assets of $46 million.

Other

In 2010, Talisman completed the sale of assets in Tunisia for proceeds of $23 million, resulting in a loss of $5 million, net of tax of $nil. An after tax writedown of $3 million had previously been recorded in 2009.

In 2009, Talisman completed the sale of assets in Trinidad and Tobago for proceeds of $278 million, resulting in a gain of $93 million, net of tax of $nil.

4. Acquisitions

Corporate Acquisitions

Jambi Merang

In 2010, Talisman acquired 100% of the share capital of Hess (Indonesia Jambi Merang) Limited, a company which owns a 25% interest in the Jambi Merang Production Sharing Contract, for cash consideration of $189 million. This acquisition, which facilitates Talisman’s strategy to increase its presence in Indonesia, was accounted for using the purchase method and the final allocation of the purchase price to the assets and liabilities acquired is as follows:

Fair value of net assets acquired	Southeast Asia
Property, plant and equipment	187
Goodwill	45
Working capital	2
Future income tax	(45)
	189

BP Exploration Company (Colombia) Limited

In 2010, Talisman entered into an agreement to acquire a 49% interest in BP Exploration Company (Colombia) Limited, which builds on the Company’s acreage position in Colombia. A cash deposit of US$613 million was paid in connection with this transaction, which has been included within other long-term assets. The transaction closed in January 2011, at which time a further cash payment of US$192 million was made. The preliminary allocation of the purchase price to the assets and liabilities acquired by Talisman will be recorded in the first quarter of 2011.

Property Acquisitions

Eagle Ford

In May 2010, Talisman completed the acquisition of 37,000 net acres of land in the Eagle Ford shale play in south Texas for $364 million in cash. In a subsequent transaction which closed in December 2010, Talisman and a subsidiary of Statoil entered into an agreement to acquire an additional 97,000 net acres of liquids-rich properties in the Eagle Ford shale play as well as an equity interest in a gas processing facility for cash consideration to Talisman of $684 million. The preliminary allocation of the purchase price to the assets and liabilities acquired by Talisman is as follows:

Fair value of net assets acquired	North America
Property, plant and equipment	1,035
Investments	13
	1,048

In a related transaction Statoil purchased a 50% working interest in Talisman’s existing 37,000 net acres in the Eagle Ford for $186 million, which was recorded as a disposition at cost. Talisman and Statoil have created a joint venture across the Eagle Ford shale play in which Talisman has a 50% interest, and with Talisman as the initial operator.

As a result of these transactions, Talisman holds approximately 78,000 net acres, predominantly in the liquids-rich area of the play. This transaction is consistent with Talisman’s intent to become a leading, returns focused shale producer in North America.

Norwegian exploration licences

In 2010, Talisman acquired a 35% working interest in the PL378 Grosbeak discovery and a 20% interest in the PL375 Beta discovery for cash consideration of $196 million. The preliminary allocation of the purchase price to the assets and liabilities acquired is as follows:

Fair value of net assets acquired	Scandinavia
Property, plant and equipment	767
Future income tax	(571)
	196

Papua New Guinea (PNG)

In 2009, Talisman completed a number of strategic acquisitions in order to expand its exploration position in PNG, including:

• acquisition of all of the outstanding shares of Rift Oil plc, a public company having 100% working interests in two exploration licences in PNG, for $198 million in cash;
• acquisition of all of the outstanding shares of Horizon Oil (Kanau) Limited, a company having interests in exploration licences in PNG, for $32 million in cash; and
• acquisition of all of the outstanding shares of Papua Petroleum Limited, a company having a 49% working interest in four exploration licences in PNG, for $23 million in cash.

The substance of these transactions was the acquisition of property.

The final allocation of the purchase price to the assets and liabilities acquired was as follows:

Fair value of net assets acquired	Southeast Asia
Property, plant and equipment	340
Working capital	(6)
Future income tax	(81)
	253

RSX Energy Inc. (RSX)

In 2008, Talisman acquired all of the outstanding shares of RSX, a public company with natural gas assets located in the Outer Foothills and Peace River areas of northern Alberta. The shares were acquired for cash consideration of $95 million and the assumption of $6 million of long-term debt. The Company acquired RSX in order to expand its undeveloped land base in the Hinton area of Alberta. The substance of the transaction was the acquisition of property.

The transaction was accounted for using the purchase method and the final allocation of the purchase price to the assets and liabilities acquired was as follows:

Fair value of net assets acquired	North America
Property, plant and equipment	131
Asset retirement obligations	(2)
Working capital	(7)
Future income tax	(21)
	101

The results of RSX are included on the Consolidated Statements of Income with effect from the date of acquisition in the first quarter of 2008.

Kurdistan region of northern Iraq

In 2009, Talisman acquired a 55% working interest in Block K9 in the Kurdistan region of northern Iraq for $29 million, plus additional payments which are dependent upon the level of estimated reserves. The Company acquired this working interest to increase its exposure to new plays and reservoirs in the Kurdistan region of northern Iraq.

In 2008, Talisman acquired a 40% working interest in Block K44 in the Kurdistan region of northern Iraq for a total cost of $252 million, plus a three-well commitment. The Company also entered into a seismic services agreement at a cost of $20 million related to Block K39 for a period of two years. In 2010, Talisman agreed to enter into a PSC as operator of Block K39.

The final allocation of the purchase price to the assets and liabilities attributable to Talisman’s interests in Block K39 and Block K44 was as follows:

Fair value of net assets acquired	Other
Property, plant and equipment	429
Future income tax	(157)
	272

Other acquisitions

In 2010, Talisman completed minor oil and gas property acquisitions in North America, Southeast Asia and the rest of the world for $120 million in cash.

In 2009, Talisman completed minor oil and gas property acquisitions in North America for $28 million in cash.

In 2008, Talisman completed minor oil and gas property acquisitions in North America for a total cost of $71 million, composed of cash of $69 million and properties exchanged of $2 million.

Goodwill

Changes in the carrying amount of the Company’s goodwill are as follows:

	2010	2009
Balance at January 11	1,176	1,187
Acquisition (see above)	45	–
Foreign currency translation	(71)	(11)
Balance at December 311	1,150	1,176

Goodwill has no tax basis.

5. Accounts Receivable

December 31	2010	2009
Trade receivables	1,242	1,225
Fair value of derivative contracts (note 15)	118	30
Note receivable (note 15)	41	–
Allowance for doubtful accounts	(2)	(2)
Total1	1,399	1,253

6. Inventories

December 31	2010	2009
Materials and supplies	67	75
Product	76	69
Total1	143	144

7. Other Assets

December 31	2010	2009
Accrued pension asset (note 23)	56	29
Fair value of derivative contracts (note 15)	24	42
Investments	120	36
Note receivable (note 15)	–	43
Asset retirement sinking fund (note 9)	30	15
Acquisition deposits	627	–
Other	4	5
Total	861	170

8. Property, Plant and Equipment, Net

December 31, 2010	Cost	Accumulated DD&A	Net book value1
Oil and gas assets	30,429	(11,823)	18,606
Corporate assets	644	(446)	198
	31,073	(12,269)	18,804

December 31, 2009	Cost	Accumulated DD&A	Net book value1
Oil and gas assets	26,940	(10,702)	16,238
Corporate assets	590	(397)	193
	27,530	(11,099)	16,431

Included in PP&E are capitalized interest costs of $99 million (2009 – $43 million) relating to major projects under construction and development. During the year ended December 31, 2010, interest costs of $83 million (2009 – $43 million; 2008 – $60 million) were capitalized.

In 2008, the Company recorded additional DD&A expense in its UK and Scandinavia segments of $410 million and $90 million, respectively, in respect of properties having no proved reserves at year-end prices.

In line with the Company’s practice of adjusting DD&A expense in the fourth quarter using year-end reserves and updated depletable costs, an incremental DD&A expense of $84 million was booked in the fourth quarter of 2008 to reflect principally price related declines in year-end reserves. For 2009, the impact of adjusting the DD&A expense in the fourth quarter was not significant as an upward price revision of 77.1 mmboe was offset by a higher depletable base and a change in production mix. For 2010, the impact of adjusting the DD&A expense in the fourth quarter was a decrease of $28 million.

As described in note 2(a), the methodology for calculating reserves changed in 2009 to using average prices. Had year-end prices been used to calculate reserves, this would not have had a significant impact on the 2009 loss from continuing operations.

In 2010, impairment expense of $118 million was recorded (2009 – $70 million; 2008 – $4 million), which arose from writing off exploration acquisition costs in North America, Scandinavia and the rest of the world for $27 million, $66 million and $25 million, respectively. The impairment charge is recorded in other expenses on the Consolidated Statements of Income (note 18).

Non-Depleted Capital

Included in PP&E are the following costs that were not subject to DD&A:

December 31	2010	2009
Undeveloped land
North America	1,751	1,112
Southeast Asia	371	333
Other	543	489
Acquired unproved reserve costs associated with producing fields1
UK	46	133
Southeast Asia	126	–
Acquired unproved reserve costs not associated with producing fields1
UK	102	111
Scandinavia	806	100
Southeast Asia	53	51
Other	14	14
Exploration costs2	996	798
Development projects3
North America	21	178
UK	218	445
Scandinavia	864	613
Southeast Asia	332	240
Other	114	56
Total	6,357	4,673

Exploration Costs

The following table provides details of the changes in the balance of exploration costs:

	December 31, 2009	Reclassified to depletable and development projects	Expensed to dry hole1	Spent during the year1	December 31, 2010
North America	194	(27)	(9)	60	218
UK	200	–	(9)	41	232
Scandinavia	43	(7)	(3)	45	78
Southeast Asia	234	(17)	–	76	293
Other	127	–	(1)	49	175
	798	(51)	(22)	271	996

	December 31, 2008	Reclassified to depletable and development projects	Expensed to dry hole1	Spent during the year1	December 31, 2009
North America	548	(241)	(212)	99	194
UK	100	–	(21)	121	200
Scandinavia	15	(4)	(4)	36	43
Southeast Asia	394	–	(166)	6	234
Other	64	–	(26)	89	127
	1,121	(245)	(429)	351	798

	December 31, 2007	Reclassified to depletable and development projects	Expensed to dry hole1	Spent during the year1	December 31, 2008
North America	492	(182)	(142)	380	548
UK	139	(5)	(42)	8	100
Scandinavia	16	–	(3)	2	15
Southeast Asia	123	(3)	–	274	394
Other	42	(27)	(5)	54	64
	812	(217)	(192)	718	1,121

Costs relating to wells drilled prior to 2010 continue to be capitalized, since management’s ongoing assessment includes further planned activity. The number of wells drilled prior to 2010 and related costs are as follows:

	Years	Number of wells	Cost
North America	2006-2009	14	134
UK	2007-2009	12	206
Scandinavia	2008-2009	4	70
Southeast Asia	2007-2009	13	231
Other	2008-2009	6	136
		49	777

North America wells drilled prior to 2010 are in the process of being evaluated or are awaiting completion of the construction of infrastructure. The remaining wells relate to fields where either further appraisal drilling is ongoing or development options are being assessed.

9. Asset Retirement Obligations (ARO)

At December 31, 2010, the estimated total undiscounted ARO associated with oil and gas properties and facilities was $4.5 billion (2009 – $4.5 billion). The majority of the payments to settle these ARO will occur over a period of 35 years and will be funded from the general resources of the Company as they arise. The ARO have been discounted using a weighted average credit adjusted risk free rate of 6.6% (2009 – 6.6%). Total accretion for the year ended December 31, 2010 of $126 million (2009 – $117 million; 2008 – $103 million) has been included in DD&A expense on the Consolidated Statements of Income.

Changes in carrying amounts of the Company’s ARO associated with its PP&E are as follows:

	2010	2009
ARO liability at January 1	2,146	1,907
Liabilities incurred during the year	51	50
Liabilities settled during the year	(37)	(50)
Accretion expense	126	117
Revisions in estimated cash flows	146	218
Foreign currency translation	(162)	(96)
ARO liability at December 311,2	2,270	2,146

Revisions in estimated cash flows occurring in 2010 related to UK obligations and were the result of revisions to estimated abandonment dates resulting from changes in oil price assumptions.

The Company provided letters of credit at January 1, 2011 in an amount of $814 million as security for the costs of future dismantlement, site restoration and abandonment obligations in the UK.

The Company has assets of $30 million that represent secured funding for its obligations in Southeast Asia (2009 – $15 million).

10. Long-Term Debt

December 31	2010	2009
Tangguh Project Financing	106	106
Debentures and Notes (Unsecured)1
6.89% notes (US$10 million), Series B, due 2010	–	10
4.44% medium term notes (C$350 million), due 20112	350	350
8.25% notes (US$50 million), due 2014	50	52
5.125% notes (US$375 million), due 20153	373	392
8.50% notes (US$150 million), due 2016	149	157
6.625% notes (UK£250 million), due 2017	388	423
7.75% notes (US$700 million), due 2019	696	733
3.75% notes (US$600 million), due 2021	597	–
7.25% debentures (US$300 million), due 2027	298	314
5.75% notes (US$125 million), due 2035	124	131
5.85% notes (US$500 million), due 2037	497	524
6.25% notes (US$600 million), due 2038	597	628
Gross debt	4,225	3,820
Prepaid financing costs	(44)	(40)
	4,181	3,780
Less: current portion	(357)	(10)
Long-term debt	3,824	3,770

Bank Credit Facilities

At December 31, 2010, Talisman had unsecured credit facilities totaling $4 billion, consisting of facilities of $3.85 billion (Facility No. 1) and $150 million (Facility No. 2). The maturity dates are November 26, 2014 for Facility No. 1 and September 30, 2012 for Facility No. 2, although these dates 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. All facilities must be repaid on their maturity dates.

Borrowings under Facility No. 1 are available in the form of prime loans, C$ or US$ bankers’ acceptances, US$ base rate loans or LIBOR based loans. In addition, drawings to a total of $1 billion are available in the form of letters of credit. Borrowings under Facility No. 2 are available in the form of prime loans, C$ or US$ bankers’ acceptances, US$ base rate loans, LIBOR based loans or letters of credit.

At December 31, 2010, the Company had not drawn against its available bank lines of credit.

Tangguh Project Financing

In connection with the acquisition of its interest in Tangguh, Talisman became a participant in a series of project financing facilities, the Company’s share of which is up to US$107 million. $106 million was outstanding under these facilities at December 31, 2010 (2009 – $106 million), which is secured by Talisman’s interest in the Tangguh LNG Project, having a net book value of $204 million. Draws under these facilities bear interest at LIBOR plus 0.19% through to LIBOR plus 0.33% per annum and will mature in 2021.

Debentures and Notes

In 2010, Talisman completed a US$600 million offering of 3.75% notes due February 2021. Interest on the notes is payable semi-annually.

In 2009, Talisman completed a private placement of US$50 million 8.25% Series A Senior Notes due March 2014 and US$150 million 8.50% Series B Senior Notes due March 2016. Interest on both notes is payable quarterly.

In 2009, Talisman completed a US$700 million offering of 7.75% notes due June 2019. Interest on the notes is payable semi-annually.

Repayment Schedule

The Company’s contractual minimum repayments of gross long-term debt are as follows:

Year
2011	357
2012	7
2013	8
2014	59
2015	384
Subsequent to 2015	3,410
Gross debt	4,225

11. Other Long-Term Obligations

December 31	2010	2009
Accrued pension and other post-employment benefits liability (note 23)	64	28
Fair value of derivative contracts (note 15)	–	7
Discounted obligations under capital leases	75	94
Long-term portion of stock based compensation liability (note 13)	44	27
Other	29	12
Total	212	168

In 2005, the Company entered into a leasing arrangement for the modification, refitting and use of a Floating Storage Offloading (FSO) vessel for use at the South Angsi development in Malaysia. An element of the leasing arrangement has been defined by the Company as a capital lease. The future minimum lease payments are US$5 million for each of the next five years and US$3 million for the remainder of the lease. The imputed rate of interest on the lease is 6%, and the lease expires in 2016. Of the total discounted liability of $24 million (2009 – $28 million), $5 million (2009 – $5 million) is included in accounts payable and accrued liabilities.

In 2009, the Company entered into a leasing arrangement for the modification, refitting and use of a FSO vessel for use at the Northern Fields development in Malaysia. An element of the leasing arrangement has been defined by the Company as a capital lease. The future minimum lease payments are US$13 million for each of the next five years and US$40 million for the remainder of the lease. The imputed rate of interest on the lease is 10%, and the lease expires in 2019. Of the total discounted liability of $69 million (2009 – $85 million), $13 million (2009 – $14 million) is included in accounts payable and accrued liabilities.

12. Capital Disclosures

Talisman’s objective in managing capital is to retain access to capital markets, ensure its ability to meet all financial obligations and meet its operational and strategic objectives.

Talisman’s capital structure consists of shareholders’ equity and long-term debt (including the current portion). The Company makes adjustments to its capital structure based on changes in economic conditions and its planned requirements. Talisman has the ability to adjust its capital structure by issuing new equity or debt, selling assets to reduce debt, controlling the amount it returns to shareholders and making adjustments to its capital expenditure program.

Talisman manages its balance sheet with reference to its liquidity and a debt-to-cash flow ratio. The main factors in assessing the Company’s liquidity are cash flow, cash provided by and used in investing activities and available bank credit facilities. The debt-to-cash flow ratio is calculated using gross debt divided by cash flow for the year.

The debt-to-cash flow ratio at December 31, 2010 and 2009 was as follows:

	2010	2009
Gross debt (note 10)	4,225	3,820
Cash flow	3,058	3,961
Debt-to-cash flow	1.38:1	0.96:1

The calculation of cash flow is as follows:

	2010	2009
Cash provided by operating activities	3,460	3,599
Changes in non-cash working capital	(402)	362
Cash flow	3,058	3,961

Talisman’s debt-to-cash flow increased from 0.96:1 at December 31, 2009 to 1.38:1 at December 31, 2010 as a result of the issuance of US$600 million of 3.75% notes and the impact of the timing of oil liftings on changes in non-cash operating working capital.

Talisman is in compliance with all of its debt covenants. The Company’s principal financial covenant under Facility No.1 is a debt-to-cash flow ratio of 3.5:1, calculated quarterly on a trailing twelve month basis.

13. Share Capital and Stock Based Compensation

Authorized

Talisman’s authorized share capital consists of an unlimited number of common shares without nominal or par value and an unlimited number of first and second preferred shares. Issued

Continuity of common shares	2010		2009		2008
	Shares	Amount	Shares	Amount	Shares	Amount
Balance, beginning of year	1,014,876,564	2,374	1,014,708,249	2,372	1,018,590,255	2,437
Issued on exercise of stock options	4,835,056	97	168,315	2	179,994	3
Shares purchased and held in trust for PSU plans (see below)	(4,482,681)	(82)	–	–	(4,062,000)	(68)
Shares released from trust for 2008 PSU plan (see below)	4,062,000	68	–	–	–	–
Balance, end of year	1,019,290,939	2,457	1,014,876,564	2,374	1,014,708,249	2,372

During 2010, Talisman declared a dividend of $0.25 per share (2009 – $0.225 per share; 2008 – $0.20 per share) for an aggregate dividend of $254 million (2009 – $229 million; 2008 – $204 million).

Subsequent to December 31, 2010, 3,186,294 stock options were exercised for shares.

No preferred shares have been issued.

Normal Course Issuer Bid

In December 2010, Talisman renewed its normal course issuer bid, pursuant to which the Company may repurchase through the facilities of the Toronto Stock Exchange and New York Stock Exchange up to 51,068,705 of its common shares (representing 5% of the common shares outstanding at November 29, 2010) during the 12-month period commencing December 15, 2010 and ending December 14, 2011.

During the years ended December 31, 2010, 2009 and 2008, Talisman did not repurchase any common shares of the Company under its normal course issuer bid.

Stock Option Plans

Talisman has stock option plans that govern the granting of options to employees and directors. All options issued by the Company permit the holder to purchase one common share of the Company at the stated exercise price or to receive a cash payment equal to the appreciated value of the stock underlying the stock option. 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.

Continuity of stock options	2010		2009		2008
	Number of options	Average exercise price ($)	Number of options	Average exercise price ($)	Number of options	Average exercise price ($)
Outstanding at January 1	69,489,526	15.22	64,877,521	15.14	63,578,912	13.21
Granted	7,743,117	17.42	12,023,390	13.37	17,071,170	17.71
Exercised for common shares	(4,835,056)	11.75	(168,315)	5.87	(179,994)	9.00
Surrendered for cash payment	(6,254,804)	12.59	(4,887,191)	9.00	(13,880,528)	9.08
Forfeited	(3,183,560)	17.81	(2,355,879)	17.03	(1,712,039)	19.11
Outstanding at December 31	62,959,223	15.89	69,489,526	15.22	64,877,521	15.14
Exercisable at December 31	35,790,358	15.59	33,825,777	13.28	30,135,489	10.80
Options available for future grants pursuant to the Company’s Stock Option Plans	42,653,842		40,928,730		45,709,050

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

December 31, 2010	Outstanding options			Exercisable options
Range of exercise prices ($)	Number of options	Weighted average exercise price ($)	Weighted average years to expiry	Number of options	Weighted average exercise price ($)
5.88 - 5.99	8,775	5.88	1	8,775	5.88
6.00 - 8.99	7,189,173	7.29	2	7,189,173	7.29
9.00 - 11.99	1,446,734	11.38	8	598,255	11.12
12.00 - 14.99	16,808,877	13.58	6	8,818,256	13.92
15.00 - 17.99	7,271,203	17.23	9	430,105	16.52
18.00 - 22.54	30,234,461	19.11	6	18,745,794	19.68
5.88 - 22.54	62,959,223	15.89	6	35,790,358	15.59

The mark-to-market liability for the stock option plans at December 31, 2010 was $344 million (2009 – $268 million), of which $301 million (2009 – $242 million) is included in accounts payable and accrued liabilities on the Consolidated Balance Sheets.

Subsequent to December 31, 2010, 157,486 stock options were surrendered for cash, 3,186,294 were exercised for shares, none were granted and 182,081 were forfeited, with 59,433,362 outstanding at February 22, 2011.

Cash Unit Plans

In addition to the Company’s stock option plans, certain of Talisman’s subsidiaries issue stock appreciation rights under the cash unit plans. Cash units are similar to stock options except that the holder does not have a right to purchase the underlying shares of the Company. Units granted under the cash unit plan are generally exercisable after three years and expire 10 years after the grant date.

Continuity of cash units	2010		2009		2008
	Number of units	Average exercise price ($)	Number of units	Average exercise price ($)	Number of units	Average exercise price ($)
Outstanding at January 1	10,078,102	16.42	9,723,082	16.52	9,970,493	15.14
Granted	1,170,920	17.38	1,403,650	13.23	2,184,940	18.06
Exercised	(826,175)	14.39	(732,565)	9.72	(1,984,466)	10.85
Forfeited	(310,055)	17.49	(316,065)	18.94	(447,885)	19.43
Outstanding at December 31	10,112,792	16.64	10,078,102	16.42	9,723,082	16.52
Exercisable at December 31	6,180,730	16.83	4,806,867	15.09	3,495,861	11.40

The range of exercise prices of the Company’s cash units is as follows:

December 31, 2010	Outstanding units			Exercisable units
Range of exercise prices ($)	Number of units	Weighted average exercise price ($)	Weighted average years to expiry	Number of units	Weighted average exercise price ($)
6.60 - 8.99	854,140	7.51	3	853,120	7.51
9.00 - 11.99	123,653	10.77	8	30,472	10.76
12.00 - 14.99	2,417,800	13.65	6	1,327,278	13.97
15.00 - 17.99	1,217,658	17.21	9	130,733	17.18
18.00 - 20.41	5,499,541	19.38	6	3,839,127	19.93
6.60 - 20.41	10,112,792	16.64	6	6,180,730	16.83

The mark-to-market liability for the cash unit plans at December 31, 2010 was $48 million (2009 – $28 million), of which $47 million (2009 – $27 million) is included in accounts payable and accrued liabilities on the Consolidated Balance Sheets.

Subsequent to December 31, 2010, 537,030 cash units were exercised, none were granted and 72,832 were forfeited, with 9,502,930 outstanding at February 22, 2011.

Long-Term Performance Share Unit (PSU) Plan

In 2009, the Company implemented a long-term PSU plan that allows for the granting of PSUs to employees. During 2010, 3,768,840 PSUs were granted pursuant to this plan which vest on December 31, 2012 (2009 – 5,791,165 PSUs were granted which vest on December 31, 2011) to varying degrees (0-150%) subject to predetermined performance measures being achieved. Each PSU represents the right, subject to performance, to receive one common share of the Company.

Continuity of long-term PSU plan	2010	2009
	Number of units	Number of units
Outstanding at January 1	5,520,158	–
Granted	3,768,840	5,791,165
Forfeited	(1,115,236)	(271,007)
Outstanding at December 31	8,173,762	5,520,158

To satisfy the Company’s obligations to deliver common shares to settle the PSUs, Talisman has arranged for a third party trustee to hold common shares which were purchased on the open market. During 2010, the Company purchased 4,482,681 common shares on the open market for $82 million. For accounting purposes, the cost of the purchase of the common shares held in trust has been accounted for as a reduction in outstanding common shares, and the trust has been consolidated in accordance with Accounting Guideline 15 since it meets the definition of a variable interest entity and the Company is the primary beneficiary of the trust. The Company is not exposed to fluctuations in the stock price in respect of the shares held in trust. Additional purchases of common shares to satisfy the Company’s obligations are contemplated.

During the year, the Company recorded stock based compensation of $40 million (2009 – $17 million), including capitalized expense of $5 million (2009 – $2 million), relating to its long-term PSU plan, with a corresponding increase in contributed surplus.

Subsequent to December 31, 2010, no long-term PSUs were granted and 47,156 were forfeited, with 8,126,606 outstanding at February 22, 2011. During this period, the Company funded the purchase of a further 368,000 common shares on the open market for $8 million to settle the PSUs.

2008 PSU Plan

In 2008, Talisman implemented a PSU plan pursuant to which 4,158,860 PSUs were granted. These PSUs vested on January 31, 2010 subject to predetermined performance measures being achieved. Based on the Company’s performance relative to these predetermined performance measures, the Board of Directors approved the vesting of 90% of the PSUs granted.

To satisfy the Company’s obligation to deliver common shares to settle the PSUs, the Company established a trust that purchased 4,062,000 common shares on the open market for $68 million in 2008. These shares were released from trust when the PSUs vested in 2010.

During the year, the Company recorded stock based compensation recovery of $3 million (2009 – $43 million expense; 2008 – $20 million expense) relating to its 2008 PSU plan, with a corresponding change in contributed surplus.

Deferred Share Unit (DSU) Plan

Talisman issues DSUs to directors in lieu of cash compensation. Each DSU represents the right to receive a cash payment on retirement equal to the market value of the Company’s shares at the time of surrender. Dividends are credited as additional DSUs when paid. At December 31, 2010, there were 330,448 (2009 – 396,550) units outstanding. The mark-to-market liability of $7 million (2009 – $8 million) is included in accounts payable and accrued liabilities on the Consolidated Balance Sheets. Expense of $nil (2009 – $4 million) related to the DSUs is recognized in general and administrative expenses on the Consolidated Statements of Income.

Restricted Share Unit (RSU) Plan

Talisman has a RSU plan that grants RSUs to eligible employees. All RSUs issued by the Company permit the holder to receive a cash payment equal to the market value of the stock. Typically, RSUs granted under the plan are paid three years after the grant date. At December 31, 2010, there were 462,133 (2009 – 342,730) units outstanding (including dividend equivalent RSUs). The mark-to-market liability of $5 million (2009 – $3 million) is included in accounts payable and accrued liabilities on the Consolidated Balance Sheets.

Stock Based Compensation

For the year ended December 31, 2010, the Company recorded stock based compensation expense of $201 million (2009 – $290 million expense; 2008 – $73 million recovery) in respect of the plans described above as follows: stock options – $145 million expense (2009 – $207 million expense; 2008 – $92 million recovery), cash units – $22 million expense (2009 – $22 million expense; 2008 – $1 million recovery), 2008 PSU plan – $3 million recovery (2009 – $43 million expense; 2008 – $20 million expense), long-term PSU plan – $35 million expense (2009 – $15 million expense) and RSUs – $2 million expense (2009 – $3 million expense; 2008 – $nil).

During the year, the Company paid cash of $55 million (2009 – $52 million; 2008 – $211 million) to employees in settlement of fully accrued option liabilities for options exercised. In addition, the Company capitalized stock based compensation expense of $29 million (2009 – $42 million; 2008 – $6 million).

Of the combined mark-to-market liability for stock option, cash unit, DSU and RSU plans of $404 million (2009 – $307 million), $360 million (2009 – $280 million) is included in accounts payable and accrued liabilities on the Consolidated Balance Sheets and $44 million (2009 – $27 million) is included in other long-term obligations.

14. Accumulated Other Comprehensive Loss

The components of accumulated other comprehensive loss are as follows:

	2010	2009	2008
Accumulated other comprehensive loss at beginning of year
Derivative financial instruments designated as cash flow hedges	–	1	(16)
Foreign currency translation adjustments	(590)	(273)	(173)
	(590)	(272)	(189)
Other comprehensive loss for the year
Derivative financial instruments designated as cash flow hedges
Unrealized gains (losses) arising during the year	14	39	(50)
Realized losses (gains) recognized in net income	(12)	(40)	67
Foreign currency translation adjustments	(625)	(317)	(100)
Transfer of accumulated foreign currency gain to net income (note 3)	(465)	–	–
	(1,088)	(318)	(83)
Accumulated other comprehensive loss at end of year
Derivative financial instruments designated as cash flow hedges	2	–	1
Foreign currency translation adjustments	(1,680)	(590)	(273)
	(1,678)	(590)	(272)

15. Financial Instruments

Talisman’s financial assets and liabilities at December 31, 2010 are composed of cash and cash equivalents, accounts receivable, note receivable, investments, bank indebtedness, accounts payable and accrued liabilities, long-term debt and risk management assets and liabilities arising from the use of derivative financial instruments.

The Company is exposed to financial risks arising from its financial assets and liabilities. The financial risks include market risk related to foreign exchange rates, interest rates and commodity prices, credit risk and liquidity risk.

Fair Value of Financial Assets and Liabilities

The fair values of cash and cash equivalents, accounts receivable (excluding the fair value of derivative contracts), bank indebtedness, and accounts payable and accrued liabilities (excluding the fair value of derivative contracts) approximate their carrying values due to the short-term maturity of those instruments. The note receivable is classified as a held-for-trading financial instrument and presented at fair value calculated using discounted cash flows, and the Black Scholes model is used to value the conversion feature. Unobservable inputs utilized to determine the fair value of the note receivable include the weighted average cost of capital and volatility of the common shares of the counterparty.

Borrowings under bank credit facilities are short-term in nature and are market rate based, thus, carrying value approximates fair value. The fair value of public debentures and notes is based on market quotations, which reflect the discounted present value of the principal and interest payments using the effective yield for instruments having the same term and risk characteristics. The fair values of private notes are based on estimations provided by third parties. The fair value of Talisman’s floating rate debt is determined by discounting future estimated coupon payments at the current market interest rate. The fair value of Talisman’s gross long-term debt at December 31 was $4.6 billion (2009 – $4 billion), while the carrying value was $4.2 billion (2009 – $3.8 billion).

Risk management assets and liabilities are recorded at their estimated fair values. To estimate fair value, the Company uses quoted market prices when available, or models that utilize observable market data. In addition to market information, the Company incorporates transaction specific details that market participants would utilize in a fair value measurement, including the impact of non-performance risk. The Company’s non-performance risk is determined based on third party quotes for debt instruments with maturity dates that are similar, or in close approximation to, the maturity dates of the corresponding financial instrument. The Company’s liabilities have decreased by $2 million as a result of incorporating non-performance risk. The Company characterizes inputs used in determining fair value using a hierarchy that prioritizes inputs depending on the degree to which they are observable. The three levels of the fair value hierarchy are as follows:

• level 1 – inputs represent quoted prices in active markets for identical assets or liabilities (for example, exchange traded commodity derivatives). Active markets are those in which transactions occur in sufficient frequency and volume to provide pricing information on an ongoing basis.
• level 2 – inputs other than quoted prices included within level that are observable, either directly or indirectly, as of the reporting date. Level 2 valuations are based on inputs, including quoted forward prices for commodities, market interest rates, and volatility factors, which can be observed or corroborated in the marketplace. The Company obtains information from sources such as the New York Mercantile Exchange (NYMEX) and independent price publications.
• level 3 – inputs that are less observable, unavailable or where the observable data do not support the majority of the instrument’s fair value, such as the Company’s internally developed assumptions about market participant assumptions used in pricing an asset or liability; for example, an estimate of future cash flows used in the Company’s internally developed present value of future cash flows model that underlies the fair value measurement.

In forming estimates, the Company utilizes the most observable inputs available for valuation purposes. If a fair value measurement reflects inputs of different levels within the hierarchy, the measurement is categorized based upon the lowest level of input that is significant to the fair value measurement. The valuation of over the counter financial swaps and collars is based on similar transactions observable in active markets or industry standard models that primarily rely on market observable inputs. Substantially all of the assumptions for industry standard models are observable in active markets throughout the full term of the instrument. These are categorized as level 2.

Fair values for cross currency and interest rate derivative instruments are determined based on the estimated cash payment or receipt necessary to settle the contract. Cash payments or receipts are based on discounted cash flow analysis using current market rates and prices. Fair values for commodity price derivatives are based on discounted cash flow analysis using current market rates and prices and option pricing models using forward pricing curves and implied volatility, as appropriate, which are compared to quotes received from financial institutions for reasonability.

The following table presents the Company’s material assets and liabilities measured at fair value for each hierarchy level as at December 31, 2010:

	Level 1 Inputs	Level 2 Inputs	Level 3 Inputs	Total Fair Value
Assets
Interest rate swaps	–	37	–	37
Cross currency swaps	–	46	–	46
Commodity collars	–	48	–	48
Commodity swaps	–	11	–	11
Note receivable	–	–	41	41
	–	142	41	183
Liabilities
Commodity collars	–	105	–	105
Commodity swaps	–	11	–	11
	–	116	–	116

The following table sets forth a reconciliation of changes in the fair value of the assets classified as level 3 in the fair value hierarchy:

	2010	2009
Balance at January 1	43	31
Realized and unrealized gains (losses)	(2)	12
Balance at December 31	41	43

Risk Management Assets, Liabilities, Gains and Losses

Derivative Instrument	Balance Sheet Caption	2010	2009
Assets
Interest rate swaps	Accounts receivable	13	13
Interest rate swaps	Other assets	24	14
Cross currency swaps	Accounts receivable	46	–
Cross currency swaps	Other assets	–	28
Commodity contracts	Accounts receivable	59	17
Risk management assets		142	72
Liabilities
Cross currency swaps	Accounts payable and accrued liabilities	–	1
Commodity contracts	Accounts payable and accrued liabilities	116	275
Commodity contracts	Other long-term obligations	–	7
Risk management liabilities		116	283

During the year, the Company recorded a gain of $102 million (2009 – $412 million loss; 2008 – $1,664 million gain) in respect of the note receivable, the fixed-to-floating interest rate swap and commodity derivative instruments designated as held-for-trading financial instruments, including a realized loss of $176 million (2009 – $989 million gain; 2008 – $442 million gain), which is included in cash provided by operating activities.

Currency Risk

Talisman’s Consolidated Financial Statements are presented in C$. Results of operations are affected primarily by the exchange rates between the C$, the US$, UK£ and NOK. These exchange rates may vary substantially. Most of the Company’s revenue is received in or is referenced to US$ denominated prices, while Talisman’s expenditures are denominated in C$, US$, UK£ and NOK. A change in the relative value of the C$ against the US$ or the UK£ would also result in an increase or decrease in Talisman’s US$ or UK£ denominated debt, as expressed in C$ and the related interest expense. Talisman is also exposed to fluctuations in other foreign currencies. Effective from the first quarter of 2011, the Company will be reporting its financial results in US$.

Talisman manages its foreign exchange exposure in a number of ways. By denominating most of its borrowings in US$, the Company is able to reduce some of its economic exposure to currency fluctuations. Talisman also manages its translation exposure by generally matching internal borrowings with its subsidiaries’ functional currencies. The Company purchases foreign currencies, mostly at spot value, to meet its current foreign currency obligations as they come due.

Talisman enters into derivative instruments from time to time to mitigate its currency risk. At December 31, 2010, the Company had cross currency interest rate swap contracts that effectively swap the 4.44% C$350 million medium term notes repaid in January 2011 into US$304 million at an interest rate of 5.05%. These contracts have been designated as a cash flow hedge. The effective portion of the changes in the fair value of the cross currency interest rate swaps is recognized initially in other comprehensive loss and is reclassified to foreign exchange gains or losses as foreign exchange translation gains or losses on the hedged debt are recorded. For the year ended December 31, 2010, the net decrease in other comprehensive loss resulting from these contracts was $2 million. The changes in the hedged item and hedging item attributable to foreign exchange are included in net income when incurred. Since the hedge was effective, the net effect of these entries had no impact on net income.

In order to reduce Talisman’s exposure to exchange rate fluctuations, the Company has designated loans denominated in the foreign currencies of its self-sustaining operations as effective net investment hedges. For the year ended December 31, 2010, gains of $22 million have been included in other comprehensive loss. These losses are attributable to the translation of Talisman’s UK£250 million denominated debt.

In respect of financial instruments existing at December 31, 2010, a 1% strengthening of the US$ against the other currencies noted above, with all other variables assumed constant, would have resulted in an increase of $7 million in net income and $3 million in other comprehensive loss in the year ended December 31, 2010. A similar weakening of the US$ would have had the opposite impact.

Interest Rate Risk

Talisman is exposed to interest rate risk principally by virtue of its borrowings. Borrowing in floating rates exposes Talisman to short-term movements in interest rates. Borrowing in fixed rates exposes Talisman to mark-to-market interest rate risk as well as reset risk (i.e. at debt maturity). Risk management activities aim to manage the mix of fixed-to-floating debt to best manage the trade-off between longer term interest rate reset risk and shorter term volatility in interest rates.

In order to mitigate its exposure to interest rate changes, Talisman enters into interest rate swaps from time to time to manage the ratio of fixed rate debt to floating rate debt. At December 31, 2010, the Company had fixed-to-floating interest rate swap contracts with a total notional amount of US$300 million that expire on May 15, 2015. During the year ended December 31, 2010, the fair value of the fixed-to-floating interest rate swaps increased by $10 million. The Company no longer designated the swap as a hedge starting in the fourth quarter of 2008.

In respect of financial instruments existing at December 31, 2010, a 1% increase in interest rates would have $nil impact on net income and $nil impact on other comprehensive loss in the year ended December 31, 2010. This result was achieved because the impact that a 1% increase in interest rates has on cash and cash equivalents and the note receivable was offset with the impact that a 1% increase in interest rates has on the Company’s interest rate swap. These items may not offset in future periods.

Credit Risk

Talisman is exposed to credit risk, which is the risk that a customer or counterparty will fail to perform an obligation or settle a liability, resulting in financial loss to the Company. Talisman manages exposure to credit risk by adopting credit risk guidelines approved by the Board of Directors that limit transactions according to counterparty creditworthiness. The Company routinely assesses the financial strength of its joint participants and customers, in accordance with the credit risk guidelines. Talisman’s credit policy requires collateral to be sought from counterparties considered to present a material risk of non-payment, which would include entities internally assessed as high risk or those with ratings below investment grade. Collateral received from customers at December 31, 2010 included $223 million of letters of credit.

A significant proportion of Talisman’s accounts receivable balance is with customers in the oil and gas industry and is subject to normal industry credit risks. At December 31, 2010, approximately 87% of the Company’s trade accounts receivable were current. Talisman had no customers with individually significant balances outstanding at December 31, 2010. Concentration of credit risk is mitigated by having a broad domestic and international customer base of highly rated counterparties.

Derivative counterparty exposure within accounts receivable increased during 2010 due principally to the increase in the fair value of natural gas commodity derivatives entered into during 2010 resulting from the reduction in the gas price. The Company diversifies its derivative counterparty exposure.

The Company also has credit risk arising from cash and cash equivalents held with banks and financial institutions. The Company’s policy allows it to deposit cash balances at financial institutions subject to a sliding scale limit, depending on creditworthiness.

The maximum credit exposure associated with financial assets is the carrying values.

Liquidity Risk

Talisman is exposed to liquidity risk, which is the risk that the Company may be unable to generate or obtain sufficient cash to meet its commitments as they come due. Talisman mitigates this risk through its management of cash, debt, committed credit capacity and its capital program.

Talisman maintains appropriate undrawn capacity in its revolving credit facilities to meet short-term fluctuations from forecasted results. Talisman manages its liquidity requirements by use of both short-term and long-term cash forecasts, and by maintaining appropriate undrawn capacity under committed bank lines.

The majority of the Company’s debt matures subsequent to 2014, with $357 million maturing in 2011.

At December 31, 2010, the Company had not drawn against its available $4 billion of bank lines of credit, $3.85 billion of which is committed through 2014. These maturity dates may be extended from time to time by agreement between the Company and the respective lenders.

Except for derivatives that mature as noted below, long-term debt that matures as outlined in note 10 and other long-term obligations detailed in note 11, all of the Company’s financial liabilities are due within one year.

Commodity Price Risk

Talisman is exposed to commodity price risk since its revenues are dependent on the price of crude oil, natural gas, and natural gas liquids. Talisman enters into derivative instruments from time to time to mitigate commodity price risk volatility under guidelines approved by the Board of Directors. The Company may hedge a portion of its future production to protect cash flows to allow it to meet its strategic objectives.

During 2010 and 2009, no gains or losses arose as a result of commodity derivative instruments designated as hedges, all such hedges having expired, and, consequently, there was no impact on recorded sales. In 2008, realized losses related to commodity derivative instruments designated as hedges resulted in a decrease of recorded sales of $28 million.

The Company had the following commodity price derivative contracts not designated as hedges outstanding at December 31, 2010:

Fixed price swaps	Term	mcf/d	C$/mcf	Fair value
ICE index	Jan-Mar 2011	17,824	6.45	(6)
ICE index	Apr-Jun 2011	16,886	5.89	(5)
				(11)

Fixed price swaps	Term	mcf/d	US$/mcf	Fair value
NYMEX index	Jan-Dec 2011	23,734	6.12	11

Two-way collars	Term	bbls/d	Floor/ceiling US$/bbl	Fair value
Dated Brent oil index	Jan-Jun 2011	20,000	80.00/92.41	(18)
Dated Brent oil index	Jan-Dec 2011	21,000	80.00/91.27	(49)
Dated Brent oil index	Jan-Dec 2011	20,000	84.00/97.57	(20)
WTI	Jan-Dec 2011	9,000	80.00/92.00	(18)
				(105)

Two-way collars	Term	mcf/d	Floor/ceiling US$/mcf	Fair value
NYMEX index	Jan-Jun 2011	95,000	5.27/6.66	12
NYMEX index	Jan-Dec 2011	71,200	6.14/6.59	36
				48

In respect of outstanding financial instruments and assuming forward commodity prices in existence at December 31, 2010, an increase of US$1/bbl in the price of oil and $0.10/mcf in the price of natural gas would have reduced the net fair value of commodity derivatives, thereby resulting in a decrease in net income of approximately $13 million for the year ended December 31, 2010. A similar decrease in commodity prices would result in an increase in net income of approximately $15 million for the year ended December 31, 2010. However, net income would also be impacted by the effect of the change in the commodity price on underlying transactions and taxes.

16. Contingencies and Commitments

Contingencies

From time to time, Talisman is the subject of litigation arising out of the Company’s operations. While Talisman assesses the merits of each lawsuit and defends itself accordingly, the Company may be required to incur significant expenses or devote significant resources to defend itself against such litigation. These claims are not expected to have a material impact on the Company’s financial position.

In September 2006, the United States District Court for the Southern District of New York (the Court) granted Talisman’s Motion for Summary Judgment, dismissing the lawsuit brought against Talisman by the Presbyterian Church of Sudan and others under the Alien Tort Claims Act. The lawsuit alleged 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 interest in oil operations in Sudan. The plaintiffs have twice attempted to certify the lawsuit as a class action. In March 2005 and in September 2005, the Court rejected the plaintiffs’ effort to certify two different classes (or groups) of plaintiffs. In October 2009, the Second Circuit Court of Appeals dismissed the plaintiff’s appeal of the Court’s decision granting Talisman’s Motion for Summary Judgment, denying class certification and refusing to consider the plaintiff’s proposed third amended complaint. On April 15, 2010, the plaintiffs requested the United States Supreme Court to permit an appeal by the plaintiffs of the Second Circuit Court of Appeals decision that dismissed their appeal. On October 4, 2010, the United States Supreme Court refused to grant the plaintiffs’ appeal request. Accordingly, the action has now been resolved in the Company’s favour.

Estimated Future Minimum Commitments¹

During the year, Talisman incurred rental expense of $593 million (2009 – $782 million; 2008 – $768 million) in respect of its operating leases.

The Company’s estimated future commitments at December 31, 2010 for 2011 and beyond are as follows:

	2011	2012	2013	2014	2015	Subsequent to 2015	Total
Office leases	43	36	35	35	12	43	204
Vessel leases	251	102	96	87	87	12	635
Transportation and processing commitments2	158	150	127	116	111	679	1,341
Minimum work commitments	442	230	117	57	20	–	866
Abandonment obligations	18	23	30	25	161	4,219	4,476
Other service contracts3	525	172	49	48	42	17	853
Total	1,437	713	454	368	433	4,970	8,375

There have been no significant changes in the Company’s expected future payment commitments, and the timing of those payments, since December 31, 2010.

Talisman’s estimated total undiscounted future ARO at December 31, 2010 was $4.5 billion (2009 – $4.5 billion), approximately 65% of which relates to Talisman’s UK operations. At December 31, 2010, Talisman had accrued $2.3 billion (2009 – $2.1 billion) of this liability. The Company had provided letters of credit at January 1, 2011 in an amount of $1.3 billion, of which $814 million were provided as security for the costs of future dismantlement, site restoration and abandonment obligations in the UK. The remaining outstanding letters of credit relate primarily to a retirement compensation arrangement, guarantees of minimum work commitments and abandonment obligations in other areas. In addition, the Company has issued guarantees as security for certain minimum work, future dismantlement, site restoration and abandonment obligations in lieu of letters of credit. Talisman has approximately $218 million of abandonment letters of credit in place from January 1, 2011 until December 31, 2011 in respect of assets held by third parties.

Talisman leases certain of its ocean going vessels and corporate offices, all of which, with the exception of the leasing arrangements described in note 11, are accounted for as operating leases. In addition to the minimum lease payments, Talisman has ongoing operating commitments associated with the vessels.

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 anticipates having sufficient production to meet these commitments.

Physical Commodity Contracts

The Company enters into fixed price sales contracts for the physical delivery of commodities. These contracts are in the regular course of business and are not intended to be settled for net cash payment. As such, the fair value of these contracts is not recognized in the Consolidated Financial Statements and future revenues are recognized in net income as earned over the term of the contract. The Company anticipates having sufficient future production to meet these fixed price sales contract commitments. The Company had the following physical commodity contracts outstanding at December 31, 2010:

	Term	mcf/d	C$/mcf
AECO natural gas swaps	Jan-Dec 2011	3,671	2.98

Long-Term Sales Contracts

In order to support the Company’s investments in natural gas projects outside of North America and the North Sea, Talisman has entered into a number of long-term sales contracts.

The majority of Talisman’s share of natural gas production from the Corridor block in Indonesia is currently sold under three long-term sales agreements with Caltex, Singapore Power and PGN. Under an amended agreement with Caltex, natural gas sales are at a price equal to 76% of the equivalent value of the Indonesia Crude Price for Duri crude oil. The minimum volume commitment under this contract is approximately 388 bcf over the remaining 11-year life of the contract. Under the agreement with Singapore Power, natural gas sales to Singapore from Corridor are referenced to a price formula which is based on the quoted spot price of fuel oil in Singapore. The minimum volume commitment is approximately 240 bcf over the remaining 13-year life of the contract. Under the agreement with PGN, natural gas sales from Corridor to PGN for their markets in West Java are at a fixed price of US$1.91/mcf, with no associated transportation costs. The minimum volume commitment is approximately 668 bcf over the remaining 13-year life of the contract.

The Company is subject to volume delivery requirements for approximately 100 mmcf/d at prices referenced to the Singapore fuel oil spot market in relation to a long-term sales contract in Malaysia/Vietnam which is currently scheduled to end in 2018. In the event these delivery requirements are not met on a daily basis within a contract year, volumes delivered in the subsequent contract year equivalent to such unmet delivery requirements are subject to a 25% price discount.

Currently, the Company anticipates having sufficient production to meet all future delivery requirements.

17. Other Revenue

Years ended December 31	2010	2009	2008
Pipeline and custom treating tariffs1	77	85	90
Investment income	11	11	14
Marketing income	22	19	8
Total	110	115	112

18. Other Expenses, Net

Years ended December 31	2010	2009	2008
Net gain on asset disposals	(59)	(37)	(66)
Foreign exchange loss (gain)	92	(15)	(165)
Property impairments (note 8)	118	70	4
Restructuring2	–	18	–
Inventory writedown	7	15	1
Bad debt expense (recovery)	–	(18)	18
Miscellaneous interest	24	18	1
Other1	12	(4)	28
Total	194	47	(179)

19. Taxes

Income Taxes

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

Years ended December 31	2010	2009	2008
Current income tax (recovery)
North America	9	182	(148)
UK	336	189	756
Scandinavia	324	51	243
Southeast Asia	306	243	353
Other	57	66	78
	1,032	731	1,282
Future income tax (recovery)
North America	(161)	(451)	494
UK	(15)	(109)	(194)
Scandinavia	(64)	6	(85)
Southeast Asia	(16)	(100)	(27)
Other	(16)	(24)	(23)
	(272)	(678)	165
Total1	760	53	1,447

The components of the net future tax liability at December 31 are as follows:

	2010	2009
Future tax liabilities
Property, plant and equipment	5,086	4,689
Other	262	186
	5,348	4,875
Future tax assets
Asset retirement obligations	1,133	1,070
Other	411	258
	1,544	1,328
Net future tax liability1	3,804	3,547

The net future tax liability at December 31 is presented in the balance sheet as follows:

	2010	2009
Future tax liabilities	3,974	3,667
Future tax assets	(170)	(120)
	3,804	3,547

Income taxes vary from the amount that would be computed by applying the Canadian statutory income tax rate of 28.26% for the year ended December 31, 2010 (2009 – 29.26%; 2008 – 29.79%) to income from continuing operations as follows:

Years ended December 31	2010	2009	2008
Income (loss) from continuing operations before taxes	1,299	(497)	4,502
Statutory income tax rate	28.26%	29.26%	29.79%
Income taxes calculated at the Canadian statutory rate	367	(145)	1,341
Increase (decrease) in income taxes resulting from:
Non-taxable expense (income)	(177)	21	(51)
Tax on items not included in income from continuing operations	130	60	(81)
Deductible PRT expense	(57)	(51)	(81)
Difference between future and statutory tax rates	13	45	(85)
Higher foreign tax rates	484	179	523
Uplift tax benefit	(74)	(70)	(53)
Stock based compensation	84	–	–
Unrecognized tax benefit	30	8	–
Other	(40)	6	(66)
Income taxes	760	53	1,447

At December 31, 2010, Talisman had unused non-capital tax losses of $1 billion (2009 – $428 million; 2008 – $102 million). The majority of these losses arose in the US and expire between 2028 and 2030.

Changes in the Company’s unrecognized tax benefit are as follows:

	2010	2009
Unrecognized tax benefit at January 1	33	67
Increases due to prior period tax positions	30	14
Decreases due to prior period tax positions	–	(55)
Increases due to settlement with taxation authorities	–	8
Decreases due to settlements with taxation authorities	(14)	(1)
Unrecognized tax benefit at December 31	49	33

Talisman’s entire unrecognized tax benefit as at December 31, 2010 and December 31, 2009, if recognized, would affect the Company’s effective tax rate.

Of the decreases due to prior period tax positions of $55 million in 2009, $49 million was the result of the Company conceding a tax position as a result of an unfavourable court decision involving another taxpayer in a similar transaction.

No significant change in the total unrecognized tax benefit is expected in 2011.

The total amount of interest and penalties included in income tax expense during the year ended December 31, 2010 was $2 million (2009 – $1 million; 2008 – $2 million). The total amount of accrued interest and penalties was $2 million at December 31, 2010 (2009 – $nil).

Talisman’s open tax years by jurisdiction are as follows:

Jurisdiction	Tax years subject to examination
Canada	1987 and later
US	2005 and later
UK	2005 and later
Norway	2003 and later
Malaysia	2004 and later
Indonesia	2005 and later
Vietnam	2005 and later

As a matter of course, Talisman is audited regularly by federal and foreign taxing authorities, but does not anticipate adjustments arising from these audits that would materially affect its financial position, results of operations or cash flows.

Petroleum Revenue Tax (PRT)

PRT expense relates primarily to the UK and is comprised of current tax expense of $127 million (2009 – $65 million; 2008 – $83 million) and future tax expense of $4 million (2009 – $43 million; 2008 – $93 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.

20. Supplemental Cash Flow Information

Items Not Involving Cash

Years ended December 31	2010	2009	2008
Depreciation, depletion and amortization	2,164	2,360	2,606
Dry hole	123	539	442
Net gain on asset disposals	(59)	(37)	(66)
Stock based compensation expense (recovery)	146	238	(284)
Future income taxes and deferred PRT (recovery)	(268)	(635)	257
Unrealized (gains) losses on held-for-trading financial instruments	(278)	1,401	(1,222)
Other	248	67	90
	2,076	3,933	1,823

Changes in Non-Cash Operating Working Capital

Years ended December 31	2010	2009	2008
Accounts receivable	(20)	(71)	3
Inventories	(15)	(17)	(43)
Prepaid expenses	(11)	3	(5)
Asset retirement obligations expenditures	(18)	(33)	(57)
Accounts payable and accrued liabilities	302	(117)	(11)
Income and other taxes payable	164	(127)	104
Net source (use) of cash	402	(362)	(9)

Other Cash Flow Information

Years ended December 31	2010	2009	2008
Cash interest paid (net of capitalized interest)	182	215	162
Cash income taxes paid	882	920	1,385

21. Cash and Cash Equivalents

Of the cash and cash equivalents balance of $1.6 billion, arising largely from the disposition of assets described in note 3, $440 million has been invested in bank deposits and the remainder in highly rated marketable securities with maturities of less than three months. At December 31, 2010, $63 million was held in escrow in connection with the December 2010 Eagle Ford transaction described in note 4.

22. Weighted Average Number of Common Shares Outstanding – Basic and Diluted

(millions)	2010	2009	2008
Weighted average number of common shares outstanding – basic	1,018	1,015	1,017
Dilution effect of stock options	19	–	17
Weighted average number of common shares outstanding – diluted	1,037	1,015	1,034

Outstanding stock options are the only instruments that are dilutive to net income per share.

In 2010, 28,301,853 (2008 – 26,985,720) stock options that were anti-dilutive were excluded from the computation of diluted net income per share. As a result of the loss from continuing operations, the effect of outstanding stock options on per share amounts was anti-dilutive in 2009.

23. Employee Benefits

The Company sponsors both defined benefit and defined contribution pension arrangements covering most employees. The Company also provides non-pension post-retirement benefits to some of its retirees.

Defined benefit pension plans are based on years of service and final average salary. The defined pension benefits in the UK and Norway, which account for 55% of the accrued benefit obligation at December 31, 2010, will increase at the rate of inflation. Although the Company has no commitment to provide for increases related to inflation on its Canadian defined benefit pension plans, the benefits have increased annually by approximately one-half of the rate of inflation since 2003.

Talisman uses actuarial reports prepared by independent actuaries on the defined benefit pension plans for funding and accounting purposes. The Company uses a December 31 measurement date to value its benefit plan assets and obligations. The most recent actuarial valuations of the Canadian registered defined benefit pension plans for funding purposes was at December 31, 2009, with the next valuations at December 31, 2012. The most recent actuarial valuation of the UK pension scheme for funding purposes was at March 31, 2009, with the next valuation at March 31, 2012.

Actuarial Assumptions

	2010	2009	2008
Accrued benefit obligation
Discount rate (%)	5.2	5.8	6.5
Rate of compensation increase (%)	4.8	4.9	4.6
Benefit expense
Discount rate (%)	5.8	6.5	5.5
Expected long-term rate of return on plan assets (%)	6.1	5.8	6.6
Assumed health care cost trend rates
Initial health care cost trend rate (%)	10.0	10.0	10.0
Health care cost trend rate declines to (%)	5.0	5.0	5.0
Year that the cost trend rate reaches final rate	2036	2036	2036

The discount rate assumptions used to determine pension and non-pension post-retirement benefits obligations and expense reflect the prevailing rates available on high-quality, fixed income debt instruments.

The expected long-term rate of return on plan assets is established by developing a forward looking, long-term return assumption for each asset class, taking into account factors such as the expected real return for the specific asset class and inflation. A single, long-term rate of return is then calculated as the weighted average of the target asset allocation and the long-term return assumption for each asset class.

Investment Policies

The Canadian registered defined benefit pension plans’ investment policy provides a framework for managing the plan assets, without undue risk of capital loss and with a reasonable expectation of a rate of return or appreciation in value. Investment managers must manage the plan assets to reasonably track the return of the appropriate index. Equity investments are passively managed to replicate the S&P/TSX Index, the S&P 500 Index and the MSCI EAFE Index. Foreign equity investments are hedged to the Canadian dollar. Investments in bonds and debentures are managed passively to replicate the DEX Long Term Bond Index and are limited to those meeting minimum credit ratings.

The UK pension scheme’s investment policy is designed to spread risks across a range of different sources. This is achieved through asset diversification so as to limit the impact of any single risk. Asset classes considered for the UK pension scheme’s investments are UK government and corporate bonds, UK equities and international equities. Plan assets are actively managed, with investment managers maintaining the target asset allocation, described below, within a 5% tolerance range.

Plan Assets

The approximate target allocation percentage for the Canadian registered defined benefit pension plans that account for 31% of total plan assets is 50% equities and 50% bonds. The approximate target allocation for the UK pension scheme that accounts for 57% of total plan assets is 45% UK equities, 35% international equities and 20% UK bonds. Plan assets do not include any common shares of Talisman, other than through equity pooled funds.

The allocation of defined benefit pension plan assets (excluding assets held in refundable tax accounts for the Canadian non-registered defined benefit pension plans) is as follows:

	2010	2009	2008
Equity securities (%)	64	60	58
Fixed income (%)	30	32	32
Cash (%)	4	6	8
Real estate (%)	2	2	2
	100	100	100

The Company characterizes inputs used in determining fair value using a hierarchy that prioritizes inputs depending on the degree to which they are observable. Refer to note 15 for details concerning the three levels of the fair value hierarchy.

The fair values of defined benefit pension plan assets (excluding assets held in refundable tax accounts for the Canadian non-registered defined benefit pension plans) at December 31, 2010 by asset category are as follows:

	Level 1 inputs	Level 2 inputs	Level 3 inputs	Total fair value
Cash	9	–	–	9
Pooled Funds:
Canadian companies	–	8	–	8
US companies	–	40	–	40
International companies	–	110	–	110
Corporate bonds	–	74	–	74
International government securities	–	9	–	9
Real estate	–	–	5	5
	9	241	5	255

Net Benefit Expense

The net benefit expense for the pension plans is as follows:

Years ended December 31	2010	2009	2008
Current service cost – defined benefit	24	20	22
Interest cost	18	16	15
Actual return on plan assets	(29)	(24)	37
Actuarial loss (gain) on accrued benefit obligation	29	42	(39)
Costs arising during the year	42	54	35
Differences between costs arising and recognized during the year
Return on plan assets	15	13	(52)
Actuarial loss (gain)	(16)	(35)	44
Prior service benefit	1	1	1
Amortization of net transitional item	–	(1)	(1)
Defined benefit plan expense	42	32	27
Defined contribution plan expense	13	14	13
Net benefit expense	55	46	40

The net benefit expense for the defined benefit pension plan 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(k).

The net benefit expense for non-pension post-retirement benefits for the year ended December 31, 2010 was $1 million (2009 – $1 million).

Obligation and Funded Status

Information about the defined benefit pension plans is as follows:

	2010		2009
	Pension plans grouped by funded status		Pension plans grouped by funded status
	Surplus1	Deficit1	Surplus1	Deficit1
Accrued benefit obligation
Accrued benefit obligation, beginning of year	60	238	54	189
Transition of plans from a deficit to a surplus position	126	(126)	–	–
Current service cost	15	9	–	20
Interest cost	12	6	4	12
Actuarial loss	13	16	6	36
Plan participants’ contributions	1	–	–	2
Benefits paid	(6)	(5)	(4)	(14)
Foreign currency translation	(13)	(2)	–	(7)
Other	–	1	–	–
Accrued benefit obligation, end of year	208	137	60	238
Plan assets
Fair value of plan assets, beginning of year	65	153	59	99
Transition of plans from a deficit to a surplus position	117	(117)	–	–
Actual return on plan assets	27	2	9	15
Employer contributions	19	12	1	59
Plan participants’ contributions	1	–	–	2
Benefits paid	(6)	(5)	(4)	(14)
Expenses	–	(1)	–	(3)
Foreign currency translation	(11)	(1)	–	(5)
Fair value of plan assets, end of year	212	43	65	153
Funded status – surplus (deficit)2	4	(94)	5	(85)
Unamortized net actuarial loss	49	39	24	62
Unamortized prior service cost	3	1	–	5
Unamortized net transitional item	–	1	–	1
Net accrued benefit asset (liability)	56	(53)	29	(17)

The projected future benefit payments for the defined benefit pension plans are as follows:

	2011	2012	2013	2014	2015	2016-2020
	12	12	12	13	14	87

During 2011, the Company expects to make contributions of $30 million to its defined benefit pension plans.

At December 31, 2010, the accrued benefit obligation for non-pension post-retirement benefits was $11 million (2009 – $11 million). Non-pension post-retirement benefits include medical, dental and life insurance benefits for current and future retirees. The effect of a 1% change in the assumed health care cost trend rates on the accrued benefit obligation and the net benefit expense would be immaterial.

24. Segmented Information

Talisman’s activities are conducted in five geographic segments: North America, UK, Scandinavia, Southeast Asia, and Other. The North America segment includes operations in Canada and the US. The Southeast Asia segment includes operations in Indonesia, Malaysia, Vietnam and Australia and exploration activities in Papua New Guinea. The Other segment includes operations in Algeria and exploration activities in Peru, Colombia and the Kurdistan region of northern Iraq. All activities relate to the exploration, development, production and transportation of oil, liquids and natural gas. Effective January 1, 2011, the composition of the Company’s segments has changed such that the activities in the UK and Scandinavia will be reported as a single ‘North Sea’ segment since, in management’s judgment, the assets in those locations now share similar economic characteristics. Prior periods will be restated accordingly in the first interim filing subsequent to the change.

	North America1			UK			Scandinavia
(millions of C$)	2010	2009	2008	2010	2009	2008	2010	2009	2008
Revenue
Gross sales	1,650	1,394	2,630	2,239	2,188	3,458	1,393	986	1,192
Hedging loss	–	–	–	–	–	(28)	–	–	–
Royalties	188	156	429	7	5	13	–	–	–
Net sales	1,462	1,238	2,201	2,232	2,183	3,417	1,393	986	1,192
Other	88	93	84	18	19	25	3	3	3
Total revenue	1,550	1,331	2,285	2,250	2,202	3,442	1,396	989	1,195
Segmented expenses
Operating	424	403	389	824	878	942	304	285	276
Transportation	61	59	68	34	46	49	64	54	35
DD&A	764	748	768	582	781	1,144	471	406	416
Dry hole expense (recovery)	(4)	134	219	62	30	93	11	69	90
Exploration	40	84	165	16	18	54	32	22	50
Other	(5)	(21)	(86)	(14)	72	23	105	(5)	15
Total segmented expenses	1,280	1,407	1,523	1,504	1,825	2,305	987	831	882
Segmented income (loss) before taxes	270	(76)	762	746	377	1,137	409	158	313
Non-segmented expenses
General and administrative
Interest on long-term debt
Stock based compensation (recovery)
Currency translation
(Gain) loss on held-for-trading financial instruments
Total non-segmented expenses
Income (loss) from continuing operations before taxes
Capital expenditure
Exploration	285	1,189	1,320	96	149	188	89	157	165
Development	1,506	264	542	507	531	545	501	528	660
Midstream	3	26	41	–	–	–	–	–	–
Exploration and development	1,794	1,479	1,903	603	680	733	590	685	825
Property acquisitions
Proceeds on dispositions
Other non-segmented
Net capital expenditures
Property, plant and equipment	7,721	6,155	6,041	4,347	4,549	4,738	2,668	2,040	1,745
Goodwill	140	149	150	265	289	306	597	628	602
Other	1,546	594	792	540	386	253	376	226	154
Discontinued operations	–	2,585	3,316	–	–	165	–	–	93
Segmented assets	9,407	9,483	10,299	5,152	5,224	5,462	3,641	2,894	2,594
Non-segmented assets
Total assets

1

North America	2010	2009	2008
Canada	1,231	1,210	2,058
US	319	121	227
Total revenue	1,550	1,331	2,285
Canada	4,991	4,993	5,240
US	2,730	1,162	801
Property, plant and equipment	7,721	6,155	6,041

	Southeast Asia2			Other3			Total
(millions of C$)	2010	2009	2008	2010	2009	2008	2010	2009	2008
Revenue
Gross sales	2,379	1,995	2,479	415	448	510	8,076	7,011	10,269
Hedging loss	–	–	–	–	–	–	–	–	(28)
Royalties	858	675	1,066	221	229	291	1,274	1,065	1,799
Net sales	1,521	1,320	1,413	194	219	219	6,802	5,946	8,442
Other	1	–	–	–	–	–	110	115	112
Total revenue	1,522	1,320	1,413	194	219	219	6,912	6,061	8,554
Segmented expenses
Operating	288	255	195	27	40	20	1,867	1,861	1,822
Transportation	61	55	48	7	8	7	227	222	207
DD&A	318	382	254	29	43	24	2,164	2,360	2,606
Dry hole expense (recovery)	31	253	13	23	53	27	123	539	442
Exploration	118	75	84	178	102	76	384	301	429
Other	21	9	29	(5)	7	5	102	62	(14)
Total segmented expenses	837	1,029	623	259	253	159	4,867	5,345	5,492
Segmented income (loss) before taxes	685	291	790	(65)	(34)	60	2,045	716	3,062
Non-segmented expenses
General and administrative							392	334	294
Interest on long-term debt							163	192	168
Stock based compensation (recovery)							201	290	(73)
Currency translation							92	(15)	(165)
(Gain) loss on held-for-trading financial instruments							(102)	412	(1,664)
Total non-segmented expenses							746	1,213	(1,440)
Income (loss) from continuing operations before taxes							1,299	(497)	4,502
Capital expenditure
Exploration	242	233	318	285	217	149	997	1,945	2,140
Development	324	444	459	97	46	8	2,935	1,813	2,214
Midstream	–	–	–	–	–	–	3	26	41
Exploration and development	566	677	777	382	263	157	3,935	3,784	4,395
Property acquisitions							1,562	438	452
Proceeds on dispositions							(393)	(323)	(100)
Other non-segmented							80	47	64
Net capital expenditures							5,184	3,946	4,811
Property, plant and equipment	3,076	2,864	2,984	992	823	814	18,804	16,431	16,322
Goodwill	148	110	129	–	–	–	1,150	1,176	1,187
Other	622	427	304	163	156	128	3,247	1,789	1,631
Discontinued operations	–	–	–	–	40	290	–	2,625	3,864
Segmented assets	3,846	3,401	3,417	1,155	1,019	1,232	23,201	22,021	23,004
Non-segmented assets							992	1,597	1,271
Total assets							24,193	23,618	24,275

2

Southeast Asia	2010	2009	2008
Indonesia	865	693	863
Malaysia	496	400	424
Vietnam	53	101	33
Australia	108	126	93
Total revenue	1,522	1,320	1,413
Indonesia	1,081	906	990
Malaysia	1,067	1,171	1,291
Vietnam	278	241	456
Papua New Guinea	426	337	–
Australia	224	209	247
Property, plant and equipment	3,076	2,864	2,984

3

Other	2010	2009	2008
Algeria	194	219	219
Total revenue	194	219	219
Algeria	249	193	221
Kurdistan	595	512	529
Other	148	118	64
Property, plant and equipment	992	823	814

25. Information Regarding United States GAAP Differences

Accounting Principles Generally Accepted in the United States

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). Differences between Canadian and US GAAP are identified below. Comparative US GAAP amounts have been restated as a result of the restatement of comparative Canadian GAAP amounts for operations classified as discontinued in 2010 (see note 3).

Balance Sheet Items in Accordance with US GAAP

		2010		2009
December 31 (millions of C$)	Notes	Canadian GAAP	US GAAP	Canadian GAAP	US GAAP
				(restated – see note 3)	(restated)
Current assets		3,208	3,208	3,154	3,154
Property, plant and equipment	1, 2, 3	18,804	18,907	16,431	16,577
Other non-current assets	4, 8, 9	2,181	2,130	4,033	3,985
Total assets		24,193	24,245	23,618	23,716
Current liabilities	8, 9	3,401	3,675	2,601	2,881
Long-term debt		3,824	3,824	3,770	3,770
Deferred income taxes	2	3,974	3,866	3,599	3,476
Other non-current liabilities	8, 9	2,515	2,572	2,537	2,645
Total liabilities		13,714	13,937	12,507	12,772
Shareholders’ equity
Common shares		2,457	2,457	2,374	2,374
Contributed surplus	5	132	149	153	170
Retained earnings	1-5, 8, 9	9,568	8,948	9,174	9,044
Accumulated other comprehensive loss	8, 10	(1,678)	(1,246)	(590)	(644)
Total liabilities and shareholders’ equity		24,193	24,245	23,618	23,716

Net Income in Accordance with US GAAP

Years ended December 31 (millions of C$)	Notes	2010	2009	2008
			(restated – see note 3)	(restated – see note 3)
Net income – Canadian GAAP		648	437	3,519
Depreciation, depletion and amortization	1, 2, 3	(15)	(16)	(19)
(Loss) gain on derivative instruments	4	23	(2)	39
Deferred income taxes	2	(15)	44	(21)
Stock based compensation	9	11	(163)	(5)
Interest on long-term debt	4	–	(3)	(3)
Loss on disposal of discontinued operations	2, 10	(494)	(25)	–
		(490)	(165)	(9)
Net income – US GAAP		158	272	3,510
Per common share amounts US GAAP (C$)
Basic
Income (loss) from continuing operations		0.40	(0.78)	2.82
Income (loss) from discontinued operations		(0.25)	1.05	0.63
Net income		0.15	0.27	3.45
Diluted
Income (loss) from continuing operations		0.40	(0.78)	2.78
Income (loss) from discontinued operations		(0.25)	1.05	0.62
Net income		0.15	0.25	3.40

Comprehensive Income (Loss) in Accordance with US GAAP

Years ended December 31 (millions of C$)	Notes	2010	2009	2008
Net income – US GAAP		158	272	3,510
Foreign currency translation adjustments		(604)	(317)	(100)
Employee benefits, net of tax	8	–	(21)	(3)
Change in fair value of cash flow hedges, net of tax		2	(1)	17
Other comprehensive loss – US GAAP		(602)	(339)	(86)
Comprehensive income (loss) – US GAAP		(444)	(67)	3,424

Statement of Cash Flow Items in Accordance with US GAAP

Years ended December 31 (millions of C$)	Notes	2010	2009	2008
Operating
Cash provided by operating activities	6	3,076	3,298	5,725
Investing
Cash used in investing activities	6	(3,350)	(1,566)	(4,545)
Financing
Cash provided by (used in) financing activities	7	275	12	(1,655)
Effect of translation on foreign currency cash and cash equivalents		(59)	(133)	32
Net increase (decrease) in cash and cash equivalents		(58)	1,611	(443)
Cash and cash equivalents, beginning of year	7	1,704	93	536
Cash and cash equivalents, end of year	7	1,646	1,704	93

GAAP Differences

25.1) Gains on Property Exchanges: In 2005, the Company early adopted a new Canadian standard that eliminated a US GAAP reconciling item on a go forward basis. Under both US and Canadian GAAP, non-monetary property exchanges are recorded at fair value unless the transaction lacks commercial substance. Prior to 2005 under both US and Canadian GAAP, property exchanges were recorded at the carrying value of the assets given up unless the exchange transaction included significant cash consideration, in which case it was recorded at fair value. Previous differences in the definition of significant cash consideration under Canadian GAAP have created differences in the carrying value of these properties and results in differences in DD&A in subsequent years.

25.2) Income Taxes and DD&A 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 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 PP&E. As a result of the implementation method, further differences in DD&A expense and the net gain on dispositions of discontinued operations result in subsequent years. Other adjustments to the Canadian GAAP net income required under US GAAP, as disclosed in this note, have been tax effected as necessary.

25.3) Impairments: In 2004, the Company adopted a Canadian standard that eliminated a US GAAP reconciling item in respect to impairments on a go forward basis. Under both US and Canadian GAAP, PP&E must be assessed for potential impairments. Under US GAAP, and effective under Canadian GAAP in 2004, 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. Prior to 2004, under Canadian GAAP, the impairment loss was the difference between the carrying value of the asset and its net recoverable amount (undiscounted). Previous impairment charges not required under Canadian GAAP have resulted in differences in DD&A expense in subsequent years.

25.4) Forward Foreign Exchange Contracts and Other Financial Instruments: The Company has designated, for Canadian GAAP purposes, some of its derivative financial instruments as hedges. In accordance with Canadian GAAP, payments or receipts on these contracts are recognized in income concurrently with the hedged transaction.

Effective January 1, 2001, the Company adopted a new US standard, 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 standard requires that changes in the derivative instrument’s fair value be recognized currently in net income unless specific hedge accounting criteria are met.

Prior to January 1, 2004, management did not designate any derivative instruments as hedges for US GAAP purposes and, accordingly, these derivative instruments were recognized on the balance sheet at their fair value with the change in their fair value recognized in net income. Subsequent to January 1, 2004 and prior to January 1, 2007, management designated commodity derivative financial instruments as hedges for US GAAP purposes and, accordingly, the changes in their fair value are recognized in other comprehensive loss with any ineffective portion recognized in net income. For fair value hedges, both the financial instrument designated as the hedging item and the portion of the underlying hedged asset or liability attributable to the hedged risk are measured at fair value. Changes in the fair value of the financial instrument designated as the hedging item and changes in the fair value of the hedged item attributable to the hedged risk are reflected in net income immediately.

Effective January 1, 2007, the Company adopted the new Canadian standards that effectively harmonize with US GAAP and, consequently, no GAAP differences arose after that date.

25.5) 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.

25.6) Cash Provided by Operating Activities Presentation: Under US GAAP, exploration expense is treated as an operating item. It is an investing item under Canadian GAAP.

25.7) Cash and Cash Equivalents: Under US GAAP, the movement in bank indebtedness is treated as a financing activity. Under Canadian GAAP, bank indebtedness is treated as a component of cash and cash equivalents.

25.8) Employee Future Benefits: In 2006, the Company adopted recognition and disclosure provisions of a new US standard, Employers’ Accounting for Defined Benefit Pension and Other Post-Retirement Plans. This standard requires the recognition of the net funded status of pension and other post-retirement plans on the balance sheet and recognition of changes in the funded status through comprehensive income (loss). Deferred actuarial losses, past service costs and the net transitional item are presented on the balance sheet in accumulated other comprehensive loss and charged to comprehensive income (loss). In order to record the difference between the funded positions of the plans and the carrying value under Canadian GAAP, other assets have decreased by $51 million (2009 – $25 million), other long-term liabilities have increased by $41 million (2009 – $67 million) and deferred tax assets have been reduced by $23 million (2009 – $23 million), with the balance of $69 million (2009 – $69 million) recorded in accumulated other comprehensive loss. Also under this standard, a company is required to measure defined benefit plan assets and obligations as of the balance sheet date; this is consistent with Talisman’s current practice and has not resulted in a GAAP difference.

Amounts in accumulated other comprehensive loss are as follows:

(millions of C$)	Surplus	Deficit	Total
Amounts not yet reflected in the net periodic benefit cost
Net transitional item	–	(1)	(1)
Past service costs	(3)	(1)	(4)
Net actuarial loss	(48)	(39)	(87)
Deferred taxes	13	10	23
Included in accumulated other comprehensive loss	(38)	(31)	(69)

The accumulated benefit obligation, which includes no allowance for future salary levels, was $263 million at December 31, 2010 (2009 – $233 million).

The amounts in accumulated other comprehensive loss that are expected to be recognized as components of net periodic benefit expense over the next fiscal year are as follows: net transitional asset of $nil, net actuarial losses of $8 million and past service costs of $1 million.

Had the pension liability been recorded in accordance with US GAAP, current liabilities would increase by $4 million and other long-term liabilities would decrease by $4 million.

25.9) Stock Based Compensation: Effective January 1, 2006, the Company adopted a new US standard, as amended, Share Based Payments, subsequent to which its stock based compensation plans are classified as liability instruments under US GAAP. Prior to 2006, there was no GAAP difference and stock based compensation was accounted for using the intrinsic value method, whereby obligations were accrued over the vesting period and represented the difference between the market value of the Company’s common shares and the exercise price of the options. Under the new standard, as amended, obligations for liability based stock compensation plans are measured at their fair value, and re-measured at fair value in each reporting date with the change in the obligation charged as stock based compensation. A description of the Company’s stock based compensation plans is provided in note 13.

Under US GAAP, the Company uses the Black Scholes option pricing model to estimate the fair value of stock based compensation plans, with the following assumptions:

	2010	2009
Expected volatility	46%	47%
Risk free interest rate	2.4%	2.8%
Expected term (years)	4.9	5.0
Expected forfeiture rate	8.6%	8.1%
Expected annual dividend yield	1.0%	1.0%

The expected volatility is based on the historical volatility of the Company’s common shares over a historical period that matches the expected term of the stock based compensation plans. The risk free rate is based on Government of Canada bond yields for terms that match the expected term of the stock based compensation plans. The expected term is based on the experienced historical holding period for stock based compensation instruments. Under liability accounting, the expected life used to determine fair value is reduced as options approach their expected life, such that options that are still outstanding beyond their expected life have no remaining time value and, accordingly, are recorded at their intrinsic value. The expected dividend rate takes into account historical dividend payments and the Company’s expectation for future payments.

For the year ended December 31, 2010, the total stock based compensation expense under US GAAP was $190 million (2009 – $453 million expense; 2008 – $68 million recovery), of which $81 million (2009 – $105 million; 2008 – $20 million recovery) is allocated to operating expenses, $80 million (2009 – $188 million; 2008 – $43 million recovery) is allocated to general and administrative expenses and $29 million (2009 – $160 million; 2008 – $5 million recovery) is allocated to exploration expenses. The stock based compensation expense net of tax was $138 million (2009 – $338 million; 2008 – $48 million recovery).

The total number of options and cash units expected to vest as at December 31, 2010 was 66.5 million, with a weighted average remaining contractual life of 6.4 years, a weighted average exercise price of $15.74 and an aggregate intrinsic value of $425 million.

The following is a summary of unvested stock based compensation activity:

	Stock Options	Average exercise price ($)	Cash Units	Average exercise price ($)
Unvested at December 31, 2008	34,742,032	18.90	6,227,221	19.39
Granted	12,023,390	13.37	1,403,650	13.23
Vested	(9,364,247)	19.31	(2,161,929)	19.50
Forfeited/expired	(1,737,426)	16.20	(197,707)	18.44
Unvested at December 31, 2009	35,663,749	17.06	5,271,235	17.63
Granted	7,743,117	17.42	1,170,920	17.38
Vested	(14,483,880)	18.83	(2,327,884)	19.72
Forfeited/expired	(1,754,121)	16.19	(182,209)	16.09
Unvested at December 31, 2010	27,168,865	16.28	3,932,062	16.33

At December 31, 2010, there was unrecognized compensation expense of $100 million (2009 – $143 million; 2008 – $54 million), which the Company expects to recognize over a weighted average period of 2.0 years (2009 – 2.2 years).

25.10) Accumulated Other Comprehensive Loss: Accumulated other comprehensive loss refers to revenues, expenses, gains and losses that are recorded as an element of shareholders’ equity but are excluded from net income. The Company’s accumulated other comprehensive loss is comprised of: (a) adjustments that result from translation of the Company’s foreign entity financial statements from their functional currencies to US dollars and the translation of US dollars consolidated financial statements to the Company’s presentation currency of C$; (b) eligible gains and losses on derivative financial instruments that are part of qualifying cash flow hedges; and (c) adjustments related to the funded status of the Company’s benefit plans.

In 2010, Talisman completed the sale of oil and gas producing properties in North America (note 3). Under Canadian GAAP, the net investment in the Company’s Canadian self-sustaining operations has been reduced as a result of these disposal transactions and a capital distribution to the parent from the subsidiary that held the assets sold and, accordingly, $465 million of non-taxable foreign exchange gains previously accumulated in other comprehensive loss were included in the carrying value of the assets used to determine the gain on disposal. US GAAP permits this accounting treatment only in the event of a complete or substantially complete liquidation of the investment in the foreign entity. Since the disposal of assets did not constitute a substantially complete liquidation of the net investment in the Company’s Canadian self-sustaining operations, no foreign exchange gains were included in the carrying value of the assets to determine the gain on disposal for US GAAP reporting purposes.

The components of accumulated other comprehensive loss for the years ended December 31, 2010, 2009 and 2008 are as follows:

(millions of C$)	Foreign Currency Translation Adjustment	Fair Value of Derivatives	Pension and Post-Retirement Benefit Plans	Total
Balance at December 31, 2007	(173)	(1)	(45)	(219)
Change in foreign currency translation adjustment	(100)	–	–	(100)
Change in fair value of derivatives (net of tax of $(13) million)	–	17	–	17
Employee benefits (net of tax of $1 million)	–	–	(3)	(3)
Balance at December 31, 2008	(273)	16	(48)	(305)
Change in foreign currency translation adjustment	(317)	–	–	(317)
Change in fair value of derivatives (net of tax of $1 million)	–	(1)	–	(1)
Employee benefits (net of tax of $7 million)	–	–	(21)	(21)
Balance at December 31, 2009	(590)	15	(69)	(644)
Change in foreign currency translation adjustment	(604)	–	–	(604)
Change in fair value of derivatives (net of tax of $1 million)	–	2	–	2
Employee benefits (net of tax of $nil)	–	–	–	–
Balance at December 31, 2010	(1,194)	17	(69)	(1,246)

25.11) Additional Information: The Company has a financing structure whereby subsidiaries have US$1.3 billion drawn on bank facilities that have been offset against equal amounts of cash deposited by another subsidiary with the same bank under a right of offset agreement. The Company intends to offset these amounts at maturity.

US Accounting Pronouncements

Effective 2011, Talisman will be reporting under IFRS without reconciliation to US GAAP. Consequently, changes in US GAAP that would ordinarily have been applicable to the Company are not presented below.

a) Extractive Activities – Oil and Gas
In 2010, the FASB issued Extractive Activities – Oil and Gas, to align the reserve calculation and disclosure requirements with the requirements in the SEC Rule, Modernization of Oil and Gas Reporting Requirements. In the fourth quarter of 2009, Talisman adopted this standard prospectively whereby yearly average commodity prices are used for purposes of calculating reserves. Previously, reserves had been calculated by reference to year-end commodity prices. Since 2009 yearly average commodity prices were higher than 2008 year-end prices. Talisman recorded an upward price revision of 77.1 mmboe to its reserves in the fourth quarter of 2009 and revised its DD&A rates accordingly.

The new standard permits companies to disclose information on probable and possible reserves. The new rules require companies to report their oil and gas reserves based on annual average prices determined by the prices in effect on the first day of each month, rather than year-end prices. In addition, the new standard adds, subject to certain exemptions, a 15% test to use as a minimum guideline for reporting “significant� reserves by geographic area, subject to various exemptions.

b) Subsequent Events
In 2009, the FASB issued Subsequent Events. The new standard reflects the existing principles of current subsequent event accounting guidance. The adoption of this standard did not have a material impact on the Company’s results or financial position.

c) Fair Value Measurement
In 2010, the FASB issued an amendment to Fair Value Measurement and Disclosure. The new standard requires entities to disclose separately significant transfers in and out of level 1 and level 2 fair value measurements. Additionally, entities are required to present separately information about purchases, sales, issuances and settlements of level 3 fair value measurements. This adoption of this amendment did not have a material impact on the Company’s results or financial position.

In 2008, Talisman adopted Fair Value Measurements, which defines fair value and establishes a framework for measuring fair value and increases disclosure concerning fair value measurements. The adoption of Fair Value Measurements did not have a material impact on Talisman’s results or financial position. The disclosure required by this standard is provided in note 15.

In 2009, the FASB issued recommendations, which amend Fair Value Measurements by providing additional guidance clarifying the measurement of liabilities at fair value. When a quoted price in an active market for the identical liability is not available, the amendments require that the fair value of the liability be measured using one or more of the listed valuation techniques that should maximize use of relevant observable inputs, and minimize the use of unobservable inputs. The adoption of this amendment did not have a material impact on Talisman’s results or financial position.

d) Derivative Instruments and Hedging Activities
In 2008, the FASB issued Disclosures about Derivative Instruments and Hedging Activities, which requires enhanced disclosure about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for, and how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. The disclosure required by this standard is provided in note 15.

e) Employee Benefits
Effective December 31, 2006, Talisman adopted the recognition and disclosure provisions of Employers’ Accounting for Defined Benefit Pension and Other Post-Retirement Plans. The adoption of the measurement provisions of this standard during 2008 did not have an impact on the Company’s results or financial position.

In 2008, the FASB issued Employers’ Disclosures about Post-Retirement Benefit Plans Assets, which requires additional disclosures explaining how investment allocation decisions are made, the major categories of plan assets, inputs and valuation techniques used to measure fair value of plan assets and significant concentrations of risk within the plan assets. The disclosure required by this standard is provided in note 23.

f) Business Combinations
In 2007, the FASB issued Business Combinations, which requires recognition of the assets acquired, liabilities assumed and non-controlling interest arising in a business combination at their fair values as of the acquisition date. In addition, the costs of acquisition must be expensed.

On January 1, 2009, Talisman adopted this standard prospectively, which did not materially impact the Company’s results of operations or financial position.

g) Accounting Standards Codification
In 2009, the FASB issued The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, which establishes the FASB Accounting Standards Codification as the sole source of authoritative US GAAP. Since the codification was not intended to change existing US GAAP, its adoption did not have an impact on Talisman’s consolidated financial statements prepared in accordance with US GAAP.

Summary US Dollar Information

Unless otherwise noted, all tabular amounts in the Consolidated Financial Statements, including accounting principles generally accepted in the US above, are reported in C$. The following information reflects summary financial information prepared in accordance with US GAAP translated from C$ to US$ at the average exchange rate prevailing in the respective year.

US$ million (except as noted)	2010	2009	2008
Total revenue1	6,711	5,308	8,025
Net income	153	238	3,293
Net income per common share (US$/share)	0.15	0.23	3.24
Average exchange rate (US$/C$)	0.9709	0.8757	0.9381