The major forms of diabetes are characterized by pancreatic islet β-cell dysfunction and decreased β-cell numbers, raising hope for cell replacement therapy. Although human islet transplantation is a cell-based therapy under clinical investigation for the treatment of type 1 diabetes, the limited availability of human cadaveric islets for transplantation will preclude its widespread therapeutic application. The result has been an intense focus on the development of alternate sources of β cells, such as through the guided differentiation of stem or precursor cell populations or the transdifferentiation of more plentiful mature cell populations. Realizing the potential for cell-based therapies, however, requires a thorough understanding of pancreas development and β-cell formation. Pancreas development is coordinated by a complex interplay of signaling pathways and transcription factors that determine early pancreatic specification as well as the later differentiation of exocrine and endocrine lineages. This review describes the current knowledge of these factors as they relate specifically to the emergence of endocrine β cells from pancreatic endoderm. Current therapeutic efforts to generate insulin-producing β-like cells from embryonic stem cells have already capitalized on recent advances in our understanding of the embryonic signals and transcription factors that dictate lineage specification and will most certainly be further enhanced by a continuing emphasis on the identification of novel factors and regulatory relationships.