Prospectus re Admission to the Official List - Heritage Oil

HERITAGE OIL CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTSYears ended December 31, 2005 and 2004(U.S. dollars)Heritage Oil Corporation (the ‘‘Corporation’’) is incorporated under the Business Corporations Act(Alberta) and its primary business activity is the exploration, development and production of petroleumand natural gas in the Middle East, Africa and Russia.The preparation of the consolidated financial statements in conformity with Canadian generally acceptedaccounting principles requires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of theconsolidated financial statements and the reported amounts of revenue and expenses during the reportingperiods. Actual results could differ from those estimates.1. Significant accounting policies:(a) Basis of presentation:The consolidated financial statements include the accounts of the Corporation, its subsidiariesand its proportionate interests in corporate joint ventures.The majority of the Corporation’s business is transacted in U.S. dollars and, accordingly, thefunctional and reporting currency is U.S. dollars.(b) Joint operations:Substantially all exploration, development and production activities are conducted jointly withothers and accordingly, the Corporation only reflects its proportionate interest in such activities.(c)Cash and cash equivalents:The Corporation considers deposits in banks, certificates of deposit and short-term investmentswith original maturities of three months or less as cash and cash equivalents.(d) Inventories:Inventories consist of petroleum, condensate and liquid petroleum gas that are recorded at thelower of cost, at average cost basis, and net realizable value.(e)Property and equipment:The Corporation follows the full cost method of accounting for petroleum and natural gasoperations, whereby all costs related to the acquisition, exploration and development ofpetroleum and natural gas interests are accumulated within cost centres on a country-by-countrybasis. Such costs include land acquisition costs, geological and geophysical expenses, carryingcharges on non-producing interests, costs of drilling both productive and non-productive wells,major development projects and overhead charges directly relating to acquisition, explorationand development activities.Proceeds from the sale of petroleum and natural gas interests are applied against capitalized costsexcept for sales that would change the rate of depletion and depreciation by 20% or more, inwhich case a gain or loss is recorded.Capitalized costs, together with estimated future capital costs associated with proved reserves, aredepleted and depreciated using the unit of production method based on estimated gross provedreserves of petroleum and natural gas as determined by independent engineers. For purposes ofthis calculation, reserves and production are converted to equivalent units of petroleum based onrelative energy content of six thousand cubic feet of natural gas to one barrel of petroleum.Costs of acquiring and evaluating significant unproved petroleum and natural gas interests areexcluded from costs subject to depletion and depreciation until it is determined that provedreserves are attributable to such interest or until impairment occurs.227