The differentiation capacity of human embryonic stem cells (hESCs) holds great promise for therapeutic applications. We report a novel three‐stage method to efficiently direct the differentiation of human embryonic stem cells into hepatic cells in serum‐free medium. Human ESCs were first differentiated into definitive endoderm cells by 3 days of Activin A treatment. Next, the presence of fibroblast growth factor‐4 and bone morphogenetic protein‐2 in the culture medium for 5 days induced efficient hepatic differentiation from definitive endoderm cells. Approximately 70% of the cells expressed the hepatic marker albumin. After 10 days of further in vitro maturation, these cells expressed the adult liver cell markers tyrosine aminotransferase, tryptophan oxygenase 2, phosphoenolpyruvate carboxykinase (PEPCK), Cyp7A1, Cyp3A4 and Cyp2B6. Furthermore, these cells exhibited functions associated with mature hepatocytes including albumin secretion, glycogen storage, indocyanine green, and low‐density lipoprotein uptake, and inducible cytochrome P450 activity. When transplanted into CCl₄ injured severe combined immunodeficiency mice, these cells integrated into the mouse liver and expressed human alpha‐1 antitrypsin for at least 2 months. In addition, we found that the hESC‐derived hepatic cells were readily infected by human immunodeficiency virus‐hepatitis C virus pseudotype viruses. Conclusion: We have developed an efficient way to direct the differentiation of human embryonic stem cells into cells that exhibit characteristics of mature hepatocytes. Our studies should facilitate searching the molecular mechanisms underlying human liver development, and form the basis for hepatocyte transplantation and drug tests. (HEPATOLOGY 2007;45:1229–1239.)