Aims/hypothesis The relative lack of successful pancreatic differentiation of human embryonic stem cells (hESCs) may suggest that directed differentiation of hESCs into definitive endoderm and subsequent commitment towards a pancreatic fate are not readily achieved. The aim of this study was to investigate whether sequential exposure of hESCs to epigenetic signals that mimic in vivo pancreatic development can efficiently generate pancreatic endodermal cells, and whether these cells can be further matured and reverse hyperglycaemia upon transplantation. Materials and methods The hESCs were sequentially treated with serum, activin and retinoic acid (RA) during embryoid body formation. The patterns of gene expression and protein production associated with embryonic germ layers and pancreatic endoderm were analysed by RT-PCR and immunostaining. The developmental competence and function of hESC-derived PDX1-positive cells were evaluated after in vivo transplantation. Results Sequential treatment with serum, activin and RA highly upregulated the expression of the genes encoding forkhead box protein A2 (FOXA2), SRY-box containing gene 17 (SOX17), pancreatic and duodenal homeobox 1 (PDX1) and homeobox HB9 (HLXB9). The population of pancreatic endodermal cells that produced PDX1 was significantly increased at the expense of ectodermal differentiation, and a subset of the PDX1-positive cells also produced FOXA2, caudal-type homeobox transcription factor 2 (CDX2), and nestin (NES). After transplantation, the PDX1-positive cells further differentiated into mature cell types producing insulin and glucagon, resulting in amelioration of hyperglycaemia and weight loss in streptozotocin-treated diabetic mice. Conclusions/interpretation Our strategy allows the progressive differentiation of hESCs into pancreatic endoderm capable of generating mature pancreatic cell types that function in vivo. These findings may establish the basis of further investigations for the purification of transplantable islet progenitors derived from hESCs.