Exhibit
1.2


Consolidated
Financial Statements and Notes
 2007







February 7, 2008
              PricewaterhouseCoopers
      LLP/s.r.l./s.e.n.c.r.l.
                Chartered
      Accountants
                1250
      René-Lévesque Boulevard West Suite 2800
                Montréal,
      Quebec
                Canada
      H3B 2G4
                Telephone
      +1 514 205 5000
                Facsimile
      +1 514 876 1502
  Independent
Auditors’ Report
  To
the Shareholders of ACE Aviation Holdings Inc.
  We have
completed integrated audits of the consolidated financial statements and
internal control over financial reporting of ACE Aviation Holdings Inc. (the
‘‘Corporation’’) as at December 31, 2007 and December 31, 2006. Our opinions,
based on our audits, are presented below.
  Consolidated
Financial statements
  We have
audited the accompanying consolidated statements of financial position of ACE
Aviation Holdings Inc. as at December 31, 2007 and December 31, 2006, and the
related consolidated statements of operations, statements of changes in
shareholders’ equity, statements of comprehensive income and cash flows for each
of the years then ended. These financial statements are the responsibility of
the Corporation’s management. Our responsibility is to express an opinion on
these financial statements based on our audits.
  We
conducted our audits of the Corporation’s financial statements as at December
31, 2007 and December 31, 2006 and for each of the years then ended in
accordance with Canadian generally accepted auditing standards and the standards
of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform an audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit of financial statements includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements. A financial statement audit also includes assessing the accounting
principles used and significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
  In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of the Corporation as at
December 31, 2007 and December 31, 2006 and the results of its operations and
its cash flows for each of the years then ended in accordance with Canadian
generally accepted accounting principles.
  As
discussed in Note 2 to the financial statements, the Corporation adopted new
accounting standards related to financial instruments.
   PricewaterhouseCoopers
refers to the Canadian firm of PricewaterhouseCoopers LLP/s.r.l./s.e.n.c.r.l.
and the other member firms of PricewaterhouseCoopers International Limited, each
of which is a separate and independent legal entity.
 2
   
    Internal
control over financial reporting
  We have
also audited ACE Aviation Holdings Inc.’s internal control over financial
reporting as at December 31, 2007 based on criteria established in Internal Control - IntegratedFrameworkissued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The Corporation’s management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness of
internal control over financial reporting, appearing in “Management’s report on
internal control over financial reporting” in Section 18 of the Corporation’s
Management’s Discussion and Analysis. Our responsibility is to express an
opinion on the effectiveness of the Corporation’s internal control over
financial reporting based on our audit.
  We
conducted our audit of internal control over financial reporting in accordance
with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial
reporting was maintained in all material respects. An audit of internal control
over financial reporting includes obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exits,
testing and evaluating the design and operating effectiveness of internal
control based on the assessed risk, and performing such other procedures as we
consider necessary in the circumstances. We believe that our audit provides a
reasonable basis for our opinion.
  A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (ii)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
company’s assets that could have a material effect on the financial
statements.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
   3
   
    In our
opinion, the Corporation maintained, in all material respects, effective
internal control over financial reporting as at December 31, 2007 based on
criteria established in Internal Control — Integrated Framework issued by the
COSO.
  (signed)
PricewaterhouseCoopers LLP
  Chartered
Accountants
 
   4




Notes to the
      Consolidated
      Financial Statements2007




Consolidated
Statement of Operations
 For
      the year ended December 31(Canadian
      dollars in millions except per share figures)
              2007*
              2006Operating
      revenuesPassenger
              
              $    9,344
              $    8,969Cargo
              
              548
              625Other
              
              934
              1,06310,826
              10,657Special
      charge for Aeroplan Miles
              note
      4
              -
              (102)10,826
              10,555Operating
      expensesWages,
      salaries and benefits
              
              2,383
              2,553Aircraft
      fuel
              
              2,553
              2,546Aircraft
      rent
              
              323
              441Airport
      and navigation fees
              
              1,021
              983Aircraft
      maintenance, materials and supplies
              
              515
              471Communications
      and information technology
              
              281
              289Food,
      beverages and supplies
              
              318
              335Depreciation,
      amortization and obsolescence
              
              582
              576Commissions
              
              201
              236Capacity
      purchase with Jazz
              note
      22
              537
              -Special
      charge for labour restructuring
              note
      14
              15
              25Other
              
              1,644
              1,70510,373
              10,160Operating
      income
              
              453
              395Non-operating
      income (expense)Interest
      income
              
              126
              120Interest
      expense
              
              (420)
              (378)Interest
      capitalized
              
              108
              61Gain
      on disposal of assets
              note
      1
              1,366
              393Gain
      (loss) on financial instruments recorded at fair value
              note
      20
              26
              (18)Equity
      investment income
              note
      1
              71
              -Other
              
              (12)
              41,265
              182Income
      before the following items
              
              1,718
              577Non-controlling
      interest
              
              (157)
              (72)Foreign
      exchange gain
              
              313
              12Provision
      for income taxes
              note
      12Current
              
              (15)
              (7)Future
              
              (461)
              (102)Income
      for the year
              
              $    1,398
              $      408Earnings
      per share
              note
      17Basic
              
              $    13.51
              $     4.01Diluted
              
              $    11.44
              $     3.80
 
 *Effective
March 14, 2007, the results and financial position of Aeroplan and effective May
24, 2007, the results and financial position of Jazz are not consolidated with
ACE (Note 1). Effective October 16, 2007, the results and financial position of
ACTS are not consolidated with ACE (Note 1).
 The
accompanying notes are an integral part of the consolidated financial
statements.
 5
  Notes to the
      Consolidated
      Financial Statements2007
 Consolidated
Statement of Financial Position
 As
      at December 31(Canadian
      dollars in millions)
              
              2007*
              2006ASSETSCurrentCash
      and cash equivalents
              note
      2P
              $     2,300
              $     1,854Short-term
      investments
              note
      2Q
              839
              1,3243,139
              3,178Restricted
      cash
              note
      2R
              124
              109Accounts
      receivable
              note
      22
              793
              729Spare
      parts, materials and supplies
              
              112
              307Prepaid
      expenses and other current assets
              
              253
              127Future
      income taxes
              note
      12
              200
              5844,621
              5,034Property
      and equipment
              note
      7
              7,925
              5,989Deferred
      charges
              note
      8
              51
              116Intangible
      assets
              note
      9
              647
              1,643Deposits
      and other assets
              note
      10
              527
              323Future
      income taxes
              note
      12
              -
              336$    13,771
              $   13,441LIABILITIESCurrentAccounts
      payable and accrued liabilities
              note
      22
              $      1,266
              $     1,547Advance
      ticket sales
              
              1,245
              832Current
      portion of Aeroplan Miles obligation
              note
      4
              55
              58Current
      portion of Aeroplan deferred revenues
              note
      4
              -
              799Current
      portion of long-term debt and capital leases
              note
      11
              686
              367Current
      taxes payable
              note
      12
              -
              3453,252
              3,948Long-term
      debt and capital leases
              note
      11
              4,006
              3,759Convertible
      preferred shares
              note
      16
              182
              166Future
      income taxes
              note
      12
              50
              136Pension
      and other benefit liabilities
              note
      13
              1,824
              1,876Aeroplan
      deferred revenues
              note
      4
              -
              801Other
      long-term liabilities
              note
      14
              483
              4839,797
              11,169Non-controlling
      interest
              
              757
              695SHAREHOLDERS’
      EQUITYShare
      capital and other equity
              note
      16
              450
              742Contributed
      surplus
              
              504
              25Retained
      earnings
              
              2,209
              810Accumulated
      other comprehensive income
              note
      2M
              54
              -3,217
              1,577$    13,771
              $   13,441
 
 *Effective
March 14, 2007, the results and financial position of Aeroplan and effective May
24, 2007, the results and financial position of Jazz are not consolidated with
ACE (Note 1). Effective October 16, 2007, the results and financial position of
ACTS are not consolidated with ACE (Note 1)
 The
accompanying notes are an integral part of the consolidated financial
statements.
 Commitments
(Note 19); Contingencies, Guarantees and Indemnities (Note 21)
 
 On
behalf of the Board of Directors:
 
 
 
 /s/ Robert A.
      Milton
              
              /s/ David I.
      RichardsonRobert A.
      Milton
              
              David I.
      RichardsonChairman,
      President and Chief Executive Officer
              
              Chairman
      of the Audit, Finance and Risk Committee
    6
  Notes to the
      Consolidated
      Financial Statements2007
 Consolidated
Statement of Changes in Shareholder’s Equity
 For
      the year ended December 31(Canadian
      dollars in millions)
              
              2007
              2006Share
      capitalCommon
      shares, beginning of year
              
              $    2,188
              $    2,231Distributions
      of Aeroplan units
              note
      4
              (306)
              (59)Distributions
      of Jazz units
              note
      5
              (70)
              -Issue
      of shares through stock options exercised
              
              86
              16Common
      shares, end of year
              
              1,898
              2,188Adjustment
      to shareholders’ equity, beginning of year
              
              (1,655)
              (1,655)Total
      share capital
              
              243
              533Other
      equityConvertible
      preferred shares
              
              117
              117Convertible
      notes
              
              90
              92Total
      share capital and other equity
              
              450
              742Contributed
      surplusBalance,
      beginning of year
              
              25
              19Fair
      value of stock options issued to Corporationemployees
      recognized as compensation expense
              note
      15
              25
              13Fair
      value of exercised stock options to share capital
              
              (29)
              (7)Aeroplan
      negative investment
              note
      4
              483
              -Total
      contributed surplus
              
              504
              25Retained
      earningsBalance,
      beginning of year
              
              810
              402Cumulative
      effect of adopting new accounting policies
              note
      2M
              5
              -Repair
      Schemes and Non-compete agreement
              Note
      22
              (4)
              -811
              402Net
      income for the year
              
              1,398
              4082,209
              810Accumulated
      other comprehensive income
              note
      16Balance,
      beginning of year
              
              -
              -Cumulative
      effect of adopting new accounting policies
              note
      16
              (7)
              -Other
      comprehensive income
              
              61
              -54
              -Total
      retained earnings and
                accumulated
      other comprehensive income
              
              2,263
              810Total
      shareholders’ equity
              
              $    3,217
              $    1,577
 
 *Effective
March 14, 2007, the results and financial position of Aeroplan and effective May
24, 2007, the results and financial position of Jazz are not consolidated with
ACE (Note 1). Effective October 16, 2007, the results and financial position of
ACTS are not consolidated with ACE (Note 1).
 The
accompanying notes are an integral part of the consolidated financial
statements.
 7
 
  Notes to the
      Consolidated
      Financial Statements2007
 
 Consolidated
Statement of Comprehensive Income
 For
      the year ended December 31(Canadian
      dollars in millions)
              
              2007*
              2006Comprehensive
      incomeNet
      income for the year
              
              $    1,398
              $    408Other
      comprehensive income, net of taxes:Net
      change in unrealized loss on US Airways securities
              note
      10
              (13)
              -Reclassification
      of realized gains on US Airways
                securities
      to income
              note
      10
              (6)
              -Net
      change in unrealized gains on fuel derivatives
                under
      hedge accounting (net of taxes of $29)
              note
      20
              88
              -Reclassification
      of net realized (gains) losses on fuel
                derivatives
      to income (net of tax of $1)
              note
      20
              (6)
              -Unrealized
      loss on translation of  self-sustaining operation (net of nil
      tax)
              
              (9)
              -Proportional
      reclassification of adjustment from foreign currency translation to income
      related to the disposal of ACTS (net of nil tax)
              
              7
              -61
              -Total
      comprehensive income
              
              $    1,459
              $    408
 
 *Effective
March 14, 2007, the results and financial position of Aeroplan and effective May
24, 2007, the results and financial position of Jazz are not consolidated with
ACE (Note 1). Effective October 16, 2007, the results and financial position of
ACTS are not consolidated with ACE (Note 1).
 The
accompanying notes are an integral part of the consolidated financial
statements.
  
 8
  Notes to the
      Consolidated
      Financial Statements2007
 Consolidated
Statement of Cash Flow
 For
      the year ended December 31(Canadian
      dollars in millions)
              
              2007*
              2006Cash
      flows from (used for)OperatingNet
      income for the year
              
              $    1,398
              $       408Adjustments
      to reconcile to net cash from operationsDepreciation,
      amortization and obsolescence
              
              582
              576Gain
      on disposal of assets
              note
      1
              (1,366)
              (393)Foreign
      exchange (gain) loss
              
              (387)
              6Future
      income taxes
              
              461
              102Excess
      of employee future benefit funding over expense
              
              (205)
              (228)Increase
      (decrease) in Aeroplan miles obligation
              
              (79)
              34Non-controlling
      interest
              
              146
              52Special
      charge for Aeroplan miles
              
              -
              102Aircraft
      lease payments less than (in excess of)rent
      expense
              
              (14)
              (16)Capitalized
      interest
              
              (108)
              (61)Other
              
              29
              65Changes
      in non-cash working capital balances
              
              72
              85529
              732FinancingIssue
      of common shares
              
              56
              8Issue
      of Air Canada shares
              note
      3
              -
              187Issue
      of Jazz units
              note
      5
              -
              218Aircraft
      and facility related borrowings
              note
      11
              1,914
              397Credit
      facility borrowings - Jazz
              note
      11
              -
              113Distributions
      paid to non-controlling interest
              
              (25)
              (51)Reduction
      of long-term debt and capital lease obligations
              
              (504)
              (278)Other
              
              (38)
              (3)1,403
              591InvestingShort-term
      investments
              
              83
              (708)Proceeds
      from sale of Air Canada shares
              note
      3
              -
              304Proceeds
      from sale of Aeroplan units
              note
      4
              463
              -Proceeds
      from sale of Jazz units
              note
      5
              263
              14Proceeds
      from sale of ACTS to ACE
              note
      6
              723
              -Proceeds
      from sale of ACTS to Air Canada
              note
      6
              65
              -Proceeds
      from sale of US Airways
              
              16
              232Proceeds
      from sale of other assets
              note
      7
              90
              40Additions
      to capital assets
              
              (2,622)
              (920)Deconsolidation
      of Aeroplan cash
              note
      4
              (231)
              -Deconsolidation
      of Jazz cash
              note
      5
              (138)
              -Deconsolidation
      of ACTS cash
              note
      6
              (7)
              -Acquisition
      of Aeroman, net of cash
              note
      6
              (53)
              -Funding
      of ACTS Aero letter of credit
              note
      22
              (101)
              -Other
              
              (37)
              4(1,486)
              (1,034)Increase
      in cash and cash equivalents
              
              446
              289Cash
      and cash equivalents, beginning of year
              
              1,854
              1,565Cash
      and cash equivalents, end of year
              
              $   
       2,300
              $    1,854Cash
      payments of interest
              
              $       2
      81
              $       272Cash
      payments of income taxes
              
              $ 
              13
              $           1
 
 *Effective
March 14, 2007, the results and financial position of Aeroplan and effective May
24, 2007, the results and financial position of Jazz are not consolidated with
ACE (Note 1).  Effective October 16, 2007, the results and financial
position of ACTS are not consolidated with ACE (Note 1).
 Cash
and cash equivalents exclude Short-term investments of $839 as at December 31,
2007 ($1,324 as at December 31, 2006).
 The
accompanying notes are an integral part of the consolidated financial
statements.




9




Notes to the
      Consolidated
      Financial Statements2007






For
the year ended December 31, 2007
 (currencies
in millions – Canadian dollars)
  1.
      NATURE OF OPERATIONS
 
 ACE
Aviation Holdings Inc. ("ACE") which was incorporated on June 29, 2004, is a
holding company of various aviation interests. Reference to the "Corporation" in
the following notes to the consolidated financial statements refers to, as the
context may require, ACE and its aviation interests collectively, ACE and one or
more of its aviation interests, one or more of ACE’s aviation interests, or ACE
itself.
  During
2007 ACE had the following reportable segments: Air Canada, Aeroplan Limited
Partnership (“Aeroplan”) up to March 14, 2007, Jazz Air LP (“Jazz”) up to May
24, 2007, ACTS LP (“ACTS”) up to October 16, 2007, and Corporate Items and
Eliminations (“CIE”).
  As at
December 31, 2007, ACE holds:
 
 §
              a
      75.0%  direct ownership interest in Air
  Canada;
 §
              a
      20.1% indirect ownership interest in Aeroplan through its holding of
      Aeroplan Income Fund  (“AIF”)
units;
 §
              a
      20.1% indirect ownership interest in Jazz through its holdings of Jazz Air
      Income Fund (“JAIF”) units. As detailed in Note 24, subsequent to December
      31, 2007 ACE reduced its ownership in Jazz to 9.5%;
  and
 §
              a
      23.0% direct interest in Aero Technical Support & Services Holdings
      (“ACTS Aero”), which is the corporation that owns and operates the
      business following the monetization of ACTS (Note
  6).
  The
demand for services experienced within the segments of the Corporation varies
over the calendar year. The Air Canada segment and Jazz segment (up to May 24,
2007) have historically experienced greater demand in the second and third
quarters as a result of the high number of leisure travelers with the preference
to travel during the spring and summer months. Both segments have substantial
fixed costs in their structures that do not fluctuate with passenger demand and
load factors.  The ACTS segment (up to October 16, 2007) has
experienced lower activity in Quarter 3 as the high demand for travel during the
summer months results in airlines scheduling their maintenance service outside
of that peak travel period.
  The
notes to the consolidated financial statements describe various transactions
completed in 2007 and 2006 related to the disposition of ACE’s holdings of its
aviation interests.  The transactions include the initial public
offerings and secondary offerings of Air Canada, Aeroplan and Jazz; the
monetization of ACTS; the disposal of shareholdings in US Airways and
distributions to ACE shareholders by way of return of capital of AIF and JAIF
units.  In addition a share buyback by way of substantial issuer bid
was completed on January 10, 2008, and a sale of Jazz units was completed on
January 24, 2008 (refer to Note 24).
  Gains
on disposal realized in 2007 and 2006 as a result of transactions involving the
disposition, by way of sale, of various aviation interests were as
follows:
  2007
              2006Air
      Canada initial public offering (Note 3)
              $            -
              $      25Aeroplan
      secondary offering (Note 4)
              539
              -Jazz
      initial public offering (Note 5)
              -
              220Jazz
      secondary offering (Note 5)
              233
              -ACTS
      monetization (Note 6)
              565
              -US
      Airways (Note 10)
              8
              152Gain
      on disposal of aviation interests
              1,345
              397Other
      gains (losses)
              21
              (4)Gain
      on disposal of assets
              $    1,366
              $    393
 
  ACE
realized a gain of $190 as a result of the initial public offering of Aeroplan
in 2005.
  10
  Notes to the
      Consolidated
      Financial Statements2007
   These
consolidated financial statements are expressed in millions of Canadian dollars
and are prepared in accordance with generally accepted accounting principles
("GAAP") in Canada on a going concern basis.
  Air
Canada
  Air
Canada includes the Corporation’s principal passenger and cargo transportation
services business operated by Air Canada and related ancillary
services.
  These
services are provided through Air Canada, AC Cargo Limited Partnership (“Air
Canada Cargo”), ACGHS Limited Partnership (“Air Canada Ground Handling Services”
or “ACGHS”), and Touram Limited Partnership (“Air Canada
Vacations”).
  Air
Canada is Canada’s largest domestic and international airline and the largest
provider of scheduled passenger services in the Canadian market, the Canada - US
transborder market and in the international market to and from Canada. Certain
of the scheduled passenger services offered on domestic and US transborder
routes are provided by Jazz through the capacity purchase agreement between Air
Canada and Jazz (the “Jazz CPA”).  Through Air Canada’s global route
network, virtually every major market throughout the world is served either
directly or through the Star Alliance network. Air Canada is a founding member
of the Star Alliance network which is the world’s largest airline alliance
group.
  Air
Canada and Air Canada Cargo provide air cargo services on domestic, US
transborder and international flights. Air Canada Cargo is a major domestic air
cargo carrier and uses the entire cargo capacity on aircraft operated by Air
Canada and Jazz on domestic and transborder routes. Air Canada offers cargo
services on its international flights and currently uses one chartered all
freighter aircraft to supplement Canada-Europe services.
  Air
Canada Ground Handling Services provides passenger handling services to Air
Canada, Jazz and other airlines with a primary focus on Canadian stations.
Services covered include passenger check-in, gate management, baggage and cargo
handling and processing, cabin cleaning, de-icing as well as aircraft ramp
services.
  Touram
Limited Partnership (“Air Canada Vacations” or “ACV”) is one of Canada’s leading
tour operators. Based in Montreal and Toronto, Air Canada Vacations is a 100%
subsidiary of Air Canada and operates its business in the outgoing leisure
travel market (Caribbean, Mexico, Europe, South America and USA) through
developing, marketing and distributing vacation travel packages and services
through a network of independent travel agencies in Canada as well as ACV’s
website, aircanadavacations.com.
  Aeroplan
  Aeroplan
is Canada’s premier loyalty marketing program. Aeroplan provides its commercial
partners, including Air Canada, with loyalty marketing services designed to
stimulate demand for such partners’ products and services.
  As a
result of the distribution of Aeroplan Income Fund units on March 14, 2007, ACE
no longer consolidates the results of operations and assets and liabilities and
cash flows of Aeroplan.  ACE’s remaining investment in Aeroplan is
accounted for using the equity method (Note 4).
  Jazz
  Jazz is
the largest regional airline and second largest airline in Canada, after Air
Canada, based on fleet size and number of routes operated.  Jazz
provides service to Air Canada’s customers in lower density markets and in
higher density markets at off-peak times throughout Canada and to certain
destinations in the United States under a capacity purchase agreement between
Air Canada and Jazz that came into effect September 30, 2004 (the "Initial Jazz
CPA"), which was amended and restated effective January 1, 2006 (the "Jazz
CPA"). Under the Jazz CPA, Jazz focuses on flight operations and customer
service and Air Canada is responsible for scheduling, marketing, pricing and
related commercial activities of the regional operations. Under the Jazz CPA,
Air Canada records expenses based upon fees relating to flight operations
performed, passengers carried and other items covered by the
agreement.
  Prior
to the distribution of units on May 24, 2007 Air Canada consolidated Jazz under
ACG-15 Consolidation of Variable Interest Entities (AcG 15).  As a
result of the Corporation’s distribution of units of Jazz Air Income Fund
   11
  Notes to the
      Consolidated
      Financial Statements2007
   on May
24, 2007, ACE’s ownership interest in Jazz Air Income Fund was
reduced from 58.8% to 49.0%.  Prior to the distribution ACE exchanged
its remaining units of Jazz for JAIF units and Jazz Air Income Fund holds all of
the outstanding units of Jazz.  Effective May 24, 2007 Jazz Air Income
Fund was deemed to be the primary beneficiary of Jazz under AcG-15 Consolidation of Variable Interest
Entities,and accordingly it consolidates Jazz from that
date.  Prior to May 24, 2007 inter-company transactions were
eliminated in these consolidated financial statements.
  These
consolidated financial statements include the consolidation of Jazz operations
up to the date of the May 24, 2007 distribution and from that date ACE’s
investment in Jazz is accounted for using the equity method (Note
5).
  ACTS
  ACTS
was a full service aircraft maintenance, repair and overhaul organization and
competes on a global basis.
  On
October 16, 2007 ACE sold substantially all of the assets and liabilities of
ACTS to ACTS Aero for cash and equity (Note 6).  Following the
redemption of the exchangeable share issued to a party related to Grupo Taca and
the establishment of an initial ACTS Long Term Incentive Plan (“LTIP”), ACE
holds a 23% equity interest in ACTS Aero which purchased the assets and conducts
the business previously operated by ACTS.
  These
consolidated financial statements include the consolidation of ACTS operations
up to October 16, 2007.  From that date ACE’s investment in ACTS Aero
is accounted for using the equity method (Note 6)
  Additional
financial information on ACE operating segments is outlined in Note 18, Segment
Information.
    12
  Notes to the
      Consolidated
      Financial Statements2007
  
 2.
      SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
 
 A)
BASIS OF VALUATION
  In
accordance with Section 1625 of the CICA Handbook, Comprehensive Revaluation of
Assets and Liabilities (“CICA 1625”), ACE adopted fresh start reporting on
September 30, 2004. As a result of the financial reorganization under CCAA, the
assets and liabilities of the consolidated entity, excluding goodwill, were
comprehensively revalued to fair values.  A revaluation adjustment of
$3,395 was recorded as a credit to share capital.
  B)
PRINCIPLES OF CONSOLIDATION
  These
consolidated financial statements include the accounts of the Corporation and
its aviation interests described in Note 1, with adjustments for non-controlling
interests. The consolidated financial statements of the Corporation include the
accounts of variable interest entities for which the Corporation is the primary
beneficiary. All inter-company balances and transactions are
eliminated.
  C)
USE OF ESTIMATES
  The
preparation of financial statements in conformity with GAAP requires management
to make estimates and assumptions that affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from
those estimates.
  D)
PASSENGER AND CARGO REVENUES
  Airline
passenger and cargo advance sales are deferred and included in current
liabilities. Passenger and cargo revenues are recognized when the transportation
is provided, except for revenue on unlimited flight passes which is recognized
on a straight-line basis over the period during which the travel pass is valid.
Air Canada has formed alliances with other airlines encompassing loyalty program
participation, code sharing and coordination of services including reservations,
baggage handling and flight schedules. Revenues are allocated based upon
formulas specified in the agreements and are recognized as transportation is
provided. As described further under Aeroplan Loyalty Program, the estimated
fair value of Aeroplan Miles earned through qualifying air travel is deferred at
the time the qualifying air travel is provided. Deferred revenues from the issue
of Miles (“Miles”) to customers, including Miles sold to loyalty program
partners are recorded as passenger revenues when the transportation is provided.
Redemptions for non-passenger services are included in other
revenues.
  Air
Canada performs regular evaluations on the deferred revenue liability which may
result in adjustments being recognized as revenue. Due to the complex pricing
structures; the complex nature of interline and other commercial agreements used
throughout the industry; historical experience over a period of many years; and
other factors including refunds, exchanges and unused tickets, certain
relatively small amounts are recognized as revenue based on estimates. Events
and circumstances may result in actual results that are different from
estimates; however these differences have historically not been
material.
  E)
CAPACITY PURCHASE AGREEMENTS – JAZZ AND TIER III CARRIERS
  Air
Canada has capacity purchase agreements with certain unaffiliated regional
carriers, which are referred to as Tier III carriers, operating aircraft of 18
seats or less. Air Canada also has a capacity purchase agreement with Jazz, a
related party to the Corporation (refer to Note 22 for additional
information).  Under these agreements, Air Canada is responsible for
the marketing, ticketing and commercial arrangements relating to these flights
and records the revenue it earns under passenger revenue.  Operating
expenses under capacity purchase agreements include the capacity purchase fees
and pass-through costs, which are non-marked-up costs charged to the
Corporation, which include fuel, airport and user fees and other; these expenses
are recorded in the applicable category within the operating
expenses.
  For the
year ended December 31, 2007, passenger revenues under capacity purchase
agreements with Tier III carriers amounted to $71 ($68 - 2006). Refer to Note 22
for related party transaction amounts with Jazz.
  
 13
  Notes to the
      Consolidated
      Financial Statements2007
  F)
AEROPLAN LOYALTY PROGRAM
  Miles
that were earned by members through transportation services provided by Air
Canada and the transportation services were treated as multiple elements. Miles
were recorded at fair values with the residual allocated to transportation
services. The proceeds from the sale of Miles to loyalty program commercial
partners were deferred.
  Revenues
from Miles issued to members were recognized at the time the Miles were redeemed
except for breakage as noted below. Miles redeemed for travel on Air Canada and
Jazz were included in Passenger revenue and Miles redeemed for other than travel
were included in Other revenues.
  Based
on historical experience and current program policies the Corporation estimated
the percentage of Miles that are not expected to be redeemed, defined as
breakage. Breakage was estimated by the Corporation based on the terms and
conditions of membership and historical accumulation and redemption patterns as
adjusted for changes to any terms and conditions that affected members’
redemption practices. The estimated breakage factor was 17%. Changes in the
breakage factor were accounted for as follows: in the period of change, the
deferred revenue balance was adjusted as if the revised estimate had been used
in prior periods with the offsetting amount recorded as an adjustment to Other
revenues; and for subsequent periods, the revised estimate was used. The amount
allocated to breakage was recognized in Other revenues on a straight line basis
over a period of 30 months, which was the estimated average life of a
Mile.
  On
March 14, 2007 the Corporation deconsolidated Aeroplan therefore the current
portion of Aeroplan loyalty program deferred revenues is $nil (2006 –
$799).  Up until the date of deconsolidation the balance was based on
Management’s estimate as to the portion of the liabilities that will be redeemed
in the next twelve months. The remainder of the liabilities was carried in
Aeroplan deferred revenues.
  G)
OTHER REVENUES
  Other
revenue includes revenues from the sale of the ground portion of vacation
packages, ground handling services and other airline related services. Vacation
package revenue is recognized as services are provided over the period of the
vacation. Other airline related service revenues are recognized as the products
are sold to passengers or the services are provided.
  Other
revenue also includes revenue related to the lease or sublease of aircraft to
third parties.  Lease or sublease revenues are recognized on a
straight line basis over the term of the lease or sublease.
  Other
revenue includes certain loyalty program revenues, as described above, as well
as revenues from maintenance services and other airline related
services.
  Revenues
and costs relating to airframe maintenance services, engine and component
maintenance services are deferred and only recognized once the work has been
completed. Certain maintenance contracts are referred to as power by the hour
whereby the customer makes payments based on their aircraft utilization.
Customer receipts under a power by the hour contract are deferred in current
liabilities and recognized as revenues as maintenance services are
performed.
  Other
airline related service revenues are recognized as services are
provided.
  H)
EMPLOYEE FUTURE BENEFITS
  The
cost of pensions, other post-retirement and post-employment benefits earned by
employees is actuarially determined using the projected benefit method prorated
on service, market interest rates, and management's best estimate of expected
plan investment performance, salary escalation, retirement ages of employees and
expected health care costs.
  A
market-related valuation method is used to value plan assets for the purpose of
calculating the expected return on plan assets. Under the selected method, the
differences between investment returns during a given year and the expected
investment returns are amortized on a straight line basis over 4
years.
  Past
service costs arising from plan amendments are amortized on a straight-line
basis over the average remaining service period of employees active at the date
of amendment. This period does not exceed the average remaining service period
of such employees up to the full eligibility date. The average remaining
   14
  Notes to the
      Consolidated
      Financial Statements2007
  service
life of active employees (or average remaining life expectancy of former members
for the plan with no active members) is between 7 and 16 years for pension plans
and between 10 and 11 years for post retirement and post employment benefit
plans.
  Cumulative
unrecognized net actuarial gains and losses in excess of 10% of the greater of
the projected benefit obligation or market-related value of plan assets at the
beginning of the year are amortized over the remaining service period of active
employees.
  Some of
Air Canada’s employees perform work for related parties.  These
employees are members of Air Canada’s sponsored defined benefit pension plans
and also participate in Air Canada’s health, life and disability future benefit
plans.  These consolidated financial statements include all of the
assets and liabilities of all sponsored plans of the
Corporation.  Pension expenses are recorded net of costs recovered
from related parties pertaining to employees assigned by Air Canada to the
related parties based on an agreed upon formula.  The cost recovery
reduces Air Canada's benefit cost with an offset to related party
receivables.
  I)
EMPLOYEE PROFIT SHARING PLAN
  The
Corporation has employee profit sharing plans. Payments are calculated annually
on full calendar year results and recorded throughout the year as a charge to
salary and wage expense based on the estimated annual payment under the
plan.
  J)
STOCK-BASED COMPENSATION PLANS
  Certain
employees of the Corporation, for the relevant periods, participate in the ACE,
Air Canada, Aeroplan, Jazz and ACTS stock based compensation plans, as described
in Note 15.
  The
fair value of stock options or units granted to Corporation employees is
recognized as compensation expense and a credit to contributed surplus on a
straight line basis over the applicable vesting period. For a stock option or
unit award attributable to an employee who is eligible to retire at the grant
date, the fair value of the stock option or unit award is expensed on the grant
date. For a stock option or unit award attributable to an employee who will
become eligible to retire during the vesting period, the fair value of the stock
option or unit award is recognized over the period from the grant date to the
date the employee becomes eligible to retire. The amount of compensation cost
recognized at any date at least equals the value of the vested portion of the
options at that date.  Refer to Note 15 for a discussion of the
accelerated vesting of ACE stock options.
  ACE,
Air Canada, Aeroplan and Jazz also maintain employee share and unit purchase
plans for shares and units. Under these plans, contributions by the
Corporation’s employees are matched to a specific percentage by the Corporation.
These contributions are included in salaries, wages and benefits expense (Note
15).
  K)
MAINTENANCE AND REPAIRS
  Maintenance
and repair costs for both leased and owned aircraft, including line maintenance,
component overhaul and repair, and maintenance checks, are charged to operating
expenses as incurred, with the exception of maintenance and repair costs related
to return conditions on short-term aircraft leases, which are accrued over the
term of the lease. Line maintenance consists of routine daily and weekly
scheduled maintenance inspections and checks, overhaul and repair involves the
inspection or replacements of major parts, and maintenance checks consist of
more complex inspections and servicing of the aircraft.
  L)
OTHER OPERATING EXPENSES
  Included
in other operating expenses are expenses related to building rent and
maintenance, terminal handling, professional fees and services, crew meals and
hotels, advertising and promotion, insurance costs, credit card fees, Aeroplan
Miles redeemed for other than travel, ground costs for Air Canada Vacations
packages, and other expenses. Expenses are recognized as incurred.
  M)
FINANCIAL INSTRUMENTS AND HEDGE ACCOUNTING
  Under
the Corporation's risk management policy derivative financial instruments are
used only for risk management purposes and not for generating trading
profits.
   15
  Notes to the
      Consolidated
      Financial Statements2007
  On
January 1, 2007, the Corporation adopted CICA accounting handbook section 3855,
Financial Instruments –
Recognition and Measurement, section 3861, Financial Instruments – Disclosure
and Presentation, section 3865, Hedges, section 1530, Comprehensive Income, and
section 3251, Equity.
  Financial
assets and financial liabilities, including derivatives, are recognized on the
consolidated statement of financial position when the Corporation becomes a
party to the contractual provisions of the financial instrument or non-financial
derivative contract.  All financial instruments are required to be
measured at fair value on initial recognition except for certain related party
transactions. Measurement in subsequent periods is dependent upon the
classification of the financial instrument as held-for-trading,
held-to-maturity, available-for-sale, loans and receivables, or other financial
liabilities. The held-for-trading classification is applied when an entity is
“trading” in an instrument or alternatively the standard permits that any
financial instrument be irrevocably designated as held-for-trading. The
held-to-maturity classification is applied only if the asset has specified
characteristics and the entity has the ability and intent to hold the asset
until maturity. For financial instruments classified as other than
held-for-trading transaction costs are added to the initial fair value of the
related financial instrument.  Transaction costs related to the
revolving line of credit which are not drawn are deferred and amortized straight
line over the term of the credit facility.
  Financial
assets and financial liabilities classified as held-for-trading are measured at
fair value with changes in those fair values recognized in non-operating income
(expense). Financial assets classified as held-to-maturity, loans and
receivables, or other financial liabilities are measured at amortized cost using
the effective interest method of amortization. Financial assets classified as
available-for-sale are measured at fair value with unrealized gains and losses,
including changes in foreign exchange rates, being recognized in Other
Comprehensive Income (“OCI”), as described below.  Investments in
equity instruments classified as available-for-sale that do not have a quoted
market price in an active market are measured at cost.
  Derivative
instruments are recorded on the consolidated statement of financial position at
fair value, including those derivatives that are embedded in financial or
non-financial contracts. Changes in the fair values of derivative instruments
are recognized in non-operating income (expense) with the exception of foreign
exchange risk management contracts and derivatives designated as effective cash
flow hedges, as further described below.
  For
financial instruments measured at amortized cost, transaction costs or fees,
premiums or discounts earned or incurred are recorded, at inception, net against
the fair value of the financial instrument. Interest expense is recorded using
the effective interest method. For any guarantee issued that meets the
definition of a guarantee pursuant to Accounting Guideline 14, Disclosure of Guarantees, the
inception fair value of the obligation relating to the guarantee is recognized
and amortized over the term of the guarantee. It is the Corporation’s policy to
not re-measure the fair value of the financial guarantee unless it qualifies as
a derivative.
  The
Corporation has implemented the following classifications:
 
 §
              Cash
      and cash equivalents are classified as held-for-trading and any period
      change in fair value is recorded through net
  income.
 §
              Aircraft
      related deposits are classified as held-to-maturity investments and are
      measured at amortized cost using the effective interest rate
      method.  Interest income is recorded in net income, as
      applicable.
 §
              Accounts
      receivable are classified as loans and receivables and are measured at
      amortized cost using the effective interest rate method. Interest income
      is recorded in net income, as
applicable.
 §
              Accounts
      payable, credit facilities, bank loans and the financial liability
      component of convertible notes and convertible preferred shares are
      classified as other financial liabilities and are measured at amortized
      cost using the effective interest rate method.  Interest income
      is recorded in net income, as
applicable.
  Changes
in the fair value of foreign currency forward contracts, option agreements and
currency swap agreements used for foreign exchange risk management but not
designated as hedges for accounting purposes, are recorded in foreign exchange
gain (loss). These contracts are included in the consolidated statement of
financial position at fair value in Prepaid expenses and other current assets,
Deposits and other assets, Accounts payable and accrued liabilities, or Other
long-term liabilities as appropriate.
  The
Corporation from time to time enters into interest rate swaps to manage the
risks associated with interest rate movement on US and Canadian floating rate
debt, including anticipated debt transactions. Changes in the fair value of
these swap agreements, which are not designated as hedges for accounting
purposes, are
   16
  Notes to the
      Consolidated
      Financial Statements2007
  recognized
in income in Other non-operating income.  These contracts are included
in the consolidated statement of financial position at fair value in Prepaid
expenses and other current assets, Deposits and other assets, Accounts payable
and accrued liabilities, or Other long-term liabilities as
appropriate.
  Fuel Derivatives Under Hedge
Accounting
  The
Corporation has designated certain of its fuel derivatives as cash flow hedges.
In a cash flow hedging relationship, the effective portion of the change in the
fair value of the hedging derivative is recognized in OCI while the ineffective
portion is recognized in non-operating income (expense). Upon maturity of the
fuel derivatives, the effective gains and losses previously recognized in
Accumulated OCI (“AOCI”) are recorded in fuel expense.  The
derivatives are recorded on the consolidated statement of financial position in
Prepaid expenses and other current assets, Deposits and other assets, Accounts
payable and accrued liabilities, or Other long-term liabilities as
appropriate.
  Hedge
accounting is discontinued prospectively when the derivative no longer qualifies
as an effective hedge, or the derivative is terminated or sold, or upon the sale
or early termination of the hedged item.  The amounts previously
recognized in AOCI are reclassified to fuel expense during the periods when the
derivative matures.  If the derivative is sold prior to its maturity,
the amounts previously recognized in AOCI are reclassified to non-operating
income (expense).  Air Canada does not have a practice of selling fuel
derivatives prior to maturity.  Refer to Note 20.
  Comprehensive
Income
  OCI
represents changes in Shareholders’ equity during a period arising from
transactions and other events with non-owner sources that are recognized in
Comprehensive income, but excluded from net income. Period changes in the fair
value of the effective portion of cash flow hedging instruments are recorded in
OCI. Commencing in Quarter 1 2007, interim consolidated financial statements
include the consolidated statement of comprehensive income; items affecting OCI
are recorded prospectively commencing from January 1, 2007, including the
transition adjustments. Cumulative changes in OCI are included in AOCI, which is
presented as a new category within Shareholders’ equity on the consolidated
statement of financial position. OCI and AOCI are presented net of
tax.
  Impact Upon Adoption of CICA
accounting handbook sections 3855, 3861, 3865, 1530, and
3251
  In
accordance with the transitional provisions of the standards, prior periods have
not been restated for the adoption of CICA Sections 3855, Financial Instruments – Recognition
and Measurement, 3861, Financial Instruments – Disclosure
and Presentation,section 3865 – Hedges,section 1530, Comprehensive Income,and
3251 – Equity.
  The
transition adjustments attributable to the re-measurement of financial assets
and financial liabilities at fair value, other than financial assets classified
as available-for-sale and hedging instruments designated as cash flow hedges,
were recognized in the opening Retained earnings of the Corporation as at
January 1, 2007.  Adjustments arising from remeasuring financial
assets classified as available-for-sale at fair value were recognized in opening
AOCI as at that date.
  For the
Corporation’s fuel-hedging relationship classified as a cash flow hedge, which
qualifies for hedge accounting under the new standard, the effective portion of
any gain or loss on the hedging instruments was recognized in AOCI and the
cumulative ineffective portion was included in the opening Retained earnings of
the Corporation as at January 1, 2007.
  
 17
  Notes to the
      Consolidated
      Financial Statements2007
  Upon
adoption the Corporation recorded the following adjustments to the Consolidated
statement of financial position:
  Increase
      (decrease)Deposits
      and other assets
              $    23Future
      income taxes ($6, net of valuation allowance $6)
              -Deferred
      charges
              (29)Intangible
      Assets
              (3)Accounts
      payable and accrued liabilities
              19Long-term
      debt and capital leases
              (30)Non-controlling
      interest
              4Retained
      earnings, net of nil tax
              5Accumulated
      other comprehensive income (loss), net of tax of $4
              (7)
 
  Convertible and Other Debt
Instruments with Embedded Derivatives
  EIC-164
provides guidance on whether an issuer of certain types of convertible debt
instruments should classify the instruments as liabilities or equity, whether
the instruments contain any embedded derivatives, and how the instruments should
be accounted for and presented. The guidance also addresses earnings per share
implications. The Corporation has adopted this guidance in Quarter 1 2007 to
financial instruments accounted for in accordance with section 3855. There is no
financial statement impact as a result of the adoption of this
standard.
  N)
FOREIGN CURRENCY TRANSLATION
  Monetary
assets and liabilities denominated in foreign currencies are translated into
Canadian dollars at rates of exchange in effect at the date of the consolidated
statement of financial position. Non-monetary assets, non-monetary liabilities,
revenues and expenses arising from transactions denominated in foreign
currencies, are translated at rates of exchange in effect, which are based on
averages for the month. Adjustments to the Canadian dollar equivalent of foreign
denominated monetary assets and liabilities due to the impact of exchange rate
changes are classified on the consolidated statement of operations as a foreign
exchange gain or loss.
  O)
INCOME TAXES
  The
Corporation utilizes the liability method of accounting for income taxes under
which future income tax assets and liabilities are recognized for the estimated
future tax consequences attributable to differences between the financial
statement carrying amount and the tax basis of assets and liabilities. Future
income tax assets and liabilities are measured using substantively enacted tax
rates in effect for the year in which those temporary differences are expected
to be recovered or settled. The effect on future income tax assets and
liabilities of a change in tax rates is recognized in earnings in the period
when the change is substantively enacted. Future income tax assets are
recognized to the extent that realization is considered more likely than
not.  The benefit of future income tax assets that existed at fresh
start, and for which a valuation allowance is recorded, will be recognized first
to reduce to nil any remaining intangible assets (on a pro-rata basis) that were
recorded upon fresh start reporting with any remaining amount as a credit to
shareholders’ equity.  The benefit of future income tax assets that
arise after fresh start will be recognized in the income statement.
  P)
CASH AND CASH EQUIVALENTS
  Cash
includes $2,031 pertaining to investments with original maturities of three
months or less at December 31, 2007 (2006 – $1,730). Investments include
bankers’ acceptances, bankers discount notes, and commercial paper, which may be
liquidated promptly and have original maturities of three months or less. The
weighted average interest rate on investments as at December 31, 2007 is 4.62%
(2006 – 4.30%).  Refer to Note 10 for a discussion of non-bank
sponsored Asset Backed Commercial Paper (“ABCP”) reclassified to Deposits and
other assets as it is not expected that these amounts are collectible within one
year.
   18
  Notes to the
      Consolidated
      Financial Statements2007
  Q)
SHORT-TERM INVESTMENTS
  Short-term
investments, comprised of bankers’ acceptances and bankers’ discount notes, have
original maturities over three months, but not more than one year. The weighted
average interest rate on short-term investments as at December 31, 2007 is 4.61
% (2006 – 4.31 %).
  R)
RESTRICTED CASH
  The
Corporation has recorded $124 (2006 – $109) in restricted cash, under current
assets, representing funds held in trust by Air Canada Vacations in accordance
with regulatory requirements governing advance ticket sales, recorded under
current liabilities, for certain travel related
activities.  Restricted cash with maturities greater than one year
from the balance sheet date is recorded in Deposits and other
assets.
  S)
SPARE PARTS, MATERIALS AND SUPPLIES
  Spare
parts, materials and supplies includes repairable and expendable spare parts and
fuel inventories.  Spare parts, materials and supplies are valued at
the lower of average cost and net realizable value.
  T)
PROPERTY AND EQUIPMENT
  Property
and equipment is initially recorded at cost. Property under capital leases and
the related obligation for future lease payments are initially recorded at an
amount equal to the lesser of fair value of the property or equipment and the
present value of those lease payments.
  Property
and equipment are depreciated to estimated residual values based on the
straight-line method over their estimated service lives. Property and equipment
under capital leases and variable interest entities are depreciated to estimated
residual values over the life of the lease. Aircraft and flight equipment,
including spare engines and related parts (“rotables”) are depreciated over 20
to 25 years, with 10% to 20% estimated residual values. Aircraft reconfiguration
costs are amortized over 3-5 years. Betterments to owned aircraft are
capitalized and amortized over the remaining service life of the aircraft.
Betterments to aircraft on operating leases are amortized over the term of the
lease.
  Buildings
are depreciated over their useful lives not exceeding 40 to 50 years on a
straight line basis. An exception to this is where the useful life of the
building is greater than the term of the land lease. In these circumstances, the
building is depreciated over the life of the lease. Leasehold improvements are
amortized over the lesser of the lease term or 5 years. Ground and other
equipment is depreciated over 3 to 25 years.
  U)
INTEREST CAPITALIZED
  Interest
on funds used to finance the acquisition of new flight equipment and other
property and equipment is capitalized for periods preceding the dates that the
assets are available for service. Capitalized interest related to the
acquisition of new flight equipment and other property and equipment is included
in purchase deposits within Property and equipment (refer to Note 7).
Capitalized interest also includes financing costs charged by the manufacturer
on capital commitments as described in Note 19.
  V)
INTANGIBLE ASSETS
  As a
result of the application of fresh start reporting, intangible assets were
recorded at their estimated fair values at September 30, 2004. For periods
subsequent to September 30, 2004, intangible assets are initially recorded at
cost.  Indefinite life assets are not amortized while assets with
finite lives are amortized on a straight line basis to nil over their estimated
useful lives.
  
 19
  Notes to the
      Consolidated
      Financial Statements2007
  Estimated
      Useful LifeInternational
      route rights and slots
              IndefiniteAir
      Canada trade name
              IndefiniteAeroplan
      trade name
              IndefiniteOther
      marketing based trade names
              IndefiniteAeroplan
      contracts
              25
      yearsStar
      Alliance membership
              25
      yearsOther
      contract and customer based intangible assets
              10
      to 15 yearsTechnology
      based intangible assets
              1
      to 5 years
 
  W)
IMPAIRMENT OF LONG-LIVED ASSETS
  Long-lived
assets are tested for impairment whenever circumstances indicate that the
carrying value may not be recoverable. When events or circumstances indicate
that the carrying amount of long-lived assets, other than indefinite life
intangibles, are not recoverable, the long-lived assets are tested for
impairment by comparing the estimate of future expected cash flows to the
carrying amount of the assets or groups of assets. If the carrying value is not
recoverable from future expected cash flows, any loss is measured as the amount
by which the asset's carrying value exceeds fair value and recorded in the
period. Recoverability is assessed relative to undiscounted cash flows from the
direct use and disposition of the asset or group of assets.
  Indefinite
life intangible assets are subjected to impairment tests on an annual basis or
when events or circumstances indicate a potential impairment. If the carrying
value of such assets exceeds the fair values, the assets are written down to
fair value.
  X)
EQUITY INVESTMENTS
  Investments
subject to significant influence are initially recorded at cost (Notes 4, 5 and
6), and the carrying amount is increased or decreased to recognize the
Corporation’s proportionate share of the investee’s net profit or
loss.
  Y)
AIRCRAFT LEASE PAYMENTS IN EXCESS OF OR LESS THAN RENT EXPENSE
  Total
aircraft operating lease rentals over the lease term are amortized to operating
expense on a straight-line basis. Included in deferred charges and long-term
liabilities is the difference between the straight line aircraft rent expense
and the payments as stipulated under the lease agreement.
  Z)
ASSET RETIREMENT OBLIGATIONS
  The
Corporation records an asset and related liability for the costs associated with
the retirement of long-lived tangible assets when a legal liability to retire
such assets exists. The fair value of a liability for an asset retirement
obligation is recognized in the period in which it is incurred if a reasonable
estimate of fair value can be made. The associated asset retirement costs are
capitalized as part of the carrying amount of the long-lived asset and then
amortized over its estimated useful life. In subsequent periods, the asset
retirement obligation is adjusted for the passage of time through charges to
income and any changes in the amount of the underlying cash flows through
increases or decreases to the asset retirement obligation and related asset. A
gain or loss may be incurred upon settlement of the liability.
  AA)
RELATED PARTY TRANSACTIONS
  Related
party transactions not in the normal course of operations are measured at the
exchange amount when the change in ownership interest in the item transferred is
substantive and the exchange amount is supported by independent evidence;
otherwise it is recorded at the carrying amount. Related party transactions in
the normal course of operations are measured at the exchange
amount.
  
 20
  Notes to the
      Consolidated
      Financial Statements2007
  BB)
VARIABLE INTEREST ENTITIES
  Aircraft and Engine Leasing
Transactions
  Air
Canada has aircraft and engine leasing transactions with a number of special
purpose entities that are variable interest entities (a “VIE”) under Accounting
Guideline 15 of the CICA Handbook, Variable Interest Entities (“AcG-15”). As a
result of the Corporation being the primary beneficiary of these VIEs, the
Corporation consolidates leasing entities covering 44 aircraft and 22
engines.
  Fuel Facilities
Arrangements
  Air
Canada participates in fuel facilities arrangements operated through fuel
facility corporations (the "Fuel Facility Corporations"), along with other
airlines to contract for fuel services at various major Canadian airports. The
Fuel Facility Corporations are organizations incorporated under federal or
provincial business corporations acts in order to acquire, finance and lease
assets used in connection with the fuelling of aircraft and ground support
equipment. The Fuel Facilities Corporations operate on a cost recovery
basis.
  Under
AcG-15, Air Canada is the primary beneficiary of three of the Fuel Facilities
Corporations in Canada. Five of the Fuel Facility Corporations in which Air
Canada participates in Canada that have not been consolidated have assets of
approximately $141 and debt of approximately $119, which is Air Canada's maximum
exposure to loss without taking into consideration any cost sharing and asset
retirement obligations that would occur amongst the other contracting airlines.
Air Canada considers this loss potential as remote.
  CC)
FUTURE ACCOUNTING STANDARD CHANGES
  The
following is an overview of accounting standard changes that the Corporation
will be required to adopt in future years:
  Capital Disclosures and
Financial Instruments – Presentation and Disclosure
  The
CICA issued three new accounting standards: section 1535, Capital Disclosures, section
3862, Financial Instruments –
Disclosures, and section 3863, Financial Instruments –
Presentation. These new standards will be effective for fiscal years
beginning on or after October 1, 2007 and the Corporation will adopt them on
January 1, 2008. The Corporation is in the process of evaluating the disclosure
and presentation requirements of the new standards.
  Section
1535 establishes disclosure requirements about an entity’s capital and how it is
managed. The purpose will be to enable users of the financial statements to
evaluate the entity’s objectives, policies and processes for managing
capital.
  Sections
3862 and 3863 will replace section 3861, Financial Instruments – Disclosure
and Presentation, revising and enhancing its disclosure requirements, and
carrying forward unchanged its presentation requirements. These new sections
will place increased emphasis on disclosures about the nature and extent of
risks arising from financial instruments and how the entity manages those
risks.
  Inventories
  The
CICA issued section 3031, Inventories, which will
replace section 3030, Inventories. This new
standard is effective for fiscal years beginning on or after July 1, 2007, and
the Corporation will adopt this section on January 1, 2008.  Section
3031 provides more extensive guidance on measurement, and expands disclosure
requirements to increase transparency.  The Corporation’s accounting
policy for inventories is consistent with measurement requirements in the new
standard and therefore it is not anticipated that the results of the Corporation
will be impacted; however, additional disclosures will be required in relation
to inventories carried at net realizable value, the amount of inventories
recognized as an expense, and the amount of any write downs of
inventories.
  DD)
COMPARATIVES
  Certain
comparative figures have been reclassified to conform to the financial statement
presentation adopted in the current year.
  
 21
  Notes to the
      Consolidated
      Financial Statements2007
  
 3.
      AIR CANADA
 
 Initial
Public Offering
  On
November 24, 2006 ACE and Air Canada completed an initial public offering of an
aggregate 25 million Air Canada shares at $21 per share for net proceeds of
$491, after offering costs of $34.
  Through
the initial public offering, Air Canada sold an aggregate of 9,523,810 Variable
Voting Shares and Voting Shares for net proceeds of $187, after offering costs
of $13. In the secondary offering, ACE sold an aggregate of 15,476,190 Variable
Voting Shares and Voting Shares for net proceeds of $304, after offering costs
of $21. The offering costs incurred were allocated between ACE and Air Canada on
a pro rata basis in relation to size of the aggregate offering.
  As a
result of the Air Canada IPO, ACE recorded a dilution gain of $25 and a
non-controlling interest on the statement of financial position of $478 as a
result of the dilution of its interest in Air Canada. The dilution gain is the
net proceeds of the offering in excess of ACE’s proportionate carrying value of
its investment in Air Canada.
  A
corporate restructuring occurred in connection with the Air Canada IPO of common
shares of Air Canada. Under the corporate restructuring, Air Canada Cargo and
Air Canada Ground Handling Services became wholly owned subsidiaries of Air
Canada and ACE transferred a 51 percent ownership in Air Canada Vacations to Air
Canada.  The remaining 49 percent was sold to Air Canada on September
7, 2007 (Note 22). ACE acquired certain investments held by Air Canada in ACTS
for consideration of $673. In addition, net inter-company balances of $170 due
by ACE to Air Canada were settled.
   22
  Notes to the
      Consolidated
      Financial Statements2007
  4.
      AEROPLAN
 
 Distributions
  On
March 3, 2006, ACE completed a special distribution (by way of reduction of the
stated capital of the Class A Variable Voting Shares, Class B Voting Shares and
Preferred Shares) to its shareholders of record as at such date of 0.18 units of
Aeroplan Income Fund per Variable Voting Share, Voting Share and Preferred Share
(on an as converted basis) of ACE.  For the purposes of the
distribution, ACE converted 20,204,165 units of Aeroplan LP into 20,204,165
units of Aeroplan Income Fund which were distributed to ACE’s shareholders on
the record date.  Based on the closing price of the units of Aeroplan
Income Fund on March 3, 2006, the value of the units distributed to ACE’s
shareholders amounted to $251.
  On
October 5, 2006, the shareholders of ACE approved a statutory plan of
arrangement pursuant to the Canada Business Corporations Act. On October 6,
2006, the Quebec Superior Court issued a final order approving the statutory
plan of arrangement, which became effective October 10, 2006. The arrangement
granted authority to the board of directors of ACE to make, from time to time,
one or more distributions to ACE shareholders in an aggregate amount of up to $2
billion by way of reduction of the stated capital of the Variable Voting Shares,
Voting Shares and Preferred Shares (hereafter referred to as the
“Plan”).
  Pursuant
to the Plan, on January 10, 2007, ACE distributed to its shareholders 50 million
units of Aeroplan Income Fund, representing 0.442 units of Aeroplan Income Fund
per Variable Voting Share, Voting Share and Preferred Share (on an as converted
basis) of ACE. For the purpose of the initial distribution under the Plan, ACE
exchanged 50 million units of Aeroplan LP into 50 million units of Aeroplan
Income Fund which were distributed to ACE’s shareholders on January 10,
2007.  Based on a closing price of $17.97 per unit of Aeroplan Income
Fund on the TSX on January 10, 2007, the distribution was valued at
approximately $899.  On January 10, 2007, ACE also exchanged 60
million units of Aeroplan LP for 60 million units of Aeroplan Income Fund. The
exchange was made for internal reorganization purposes.
 
 On
March 14, 2007 ACE distributed to its shareholders of record on March 14, 2007,
20,272,917 units of Aeroplan Income Fund, representing 0.177 units of Aeroplan
Income Fund per Variable Voting Share, Voting Share and Preferred Share (on an
as converted basis). Based the closing price of $19.40 per unit of Aeroplan
Income Fund on the TSX on March 14, 2007, the value of the distribution was
approximately $393.  ACE also exchanged its remaining 40,545,835 units
of Aeroplan LP into 40,545,835 units of Aeroplan Income Fund.
  On May
24, 2007, ACE distributed to its shareholders of record 18 million units of
Aeroplan Income Fund, representing 0.157 units of Aeroplan Income Fund per
Variable Voting Share, Voting Share and Preferred Share (on an as converted
basis) of ACE. Based on the closing price of $21.50 per unit of Aeroplan Income
Fund on the TSX on May 24, 2007, the distribution was valued at approximately
$387.
  The
following table summarizes the Aeroplan units distributed to shareholders during
2007:
  Distributions
              
              
              Aeroplan
      units distributedDistributed
      to common shareholders
              
              
              79,860,637Distributed
      to preferred shareholders
              
              
              8,412,28088,272,917
 
 Since
the approval of the statutory plan of arrangement in October 2006, a total of
$1,993, comprising of Aeroplan ($1,679) and Jazz ($314) (Note 5), based on unit
prices on the respective dates of distribution, has been distributed, under the
$2 billion plan.
   23
  Notes to the
      Consolidated
      Financial Statements2007
   Distributions to Common
Shareholders
  The
distributions to holders of Variable Voting Shares and Voting Shares totaling
79,860,637 units of Aeroplan Income Fund (“Aeroplan units”) were non-monetary
non-reciprocal transfers to owners. Non-monetary non-reciprocal transfers to
owners are recorded at the carrying amount of the net assets transferred and do
not give rise to a gain or loss.  For the May 24,
2007  Aeroplan units distributed, as Aeroplan was an equity investment
at the time of distribution, $57 was recorded as a reduction of the negative
equity investment in Aeroplan offset by an increase to contributed
surplus.  The 2007 distributions involved the use of future income tax
(“FIT”) assets, of which $306 related to the distributions to the common
shareholders which was recorded as a reduction in share capital.
  Distribution
      to
                common
      shareholders
              
              
              
              Aeroplan
      units distributed
              Reduction
      to share capital due to FITJanuary
      10, 2007
              
              
              
              45,240,473
              $  (166)March
      14, 2007
              
              
              
              18,345,927
              (71)May
      24, 2007
              
              
              
              16,274,237
              (69)79,860,637
              $  (306)
 
 Distributions to Preferred
Shareholders
  The
distributions to preferred shareholders of ACE totaled 8,412,280 Aeroplan units.
These transactions were considered a non-reciprocal transfer to non-owners since
the holders of the Preferred Shares are not considered owners of the Corporation
for accounting purposes. The transfers are measured at fair value at the date of
distribution and result in net interest expense being recorded, which is the
fair value of each distribution less the gain recorded. The gain recorded is the
fair value of the distribution in excess of the Corporation’s proportionate
carrying value of its investment. The fair value of the distribution is based on
the closing price of the Aeroplan Income Fund units and Jazz Air Income Fund
units on the TSX on the day of the distribution.
  The
Aeroplan units distributed to preferred shareholders resulted in net interest
expense recorded during the year and a proportionate reduction to intangible
assets related to fair value adjustments to Aeroplan intangibles that are
recorded on consolidation as a result of the dilution of interests. The
following table summarizes the financial statement impact of the Aeroplan units
distributed to preferred shareholders:
  Distribution
      to
                preferred
      shareholders
              Aeroplan
      units distributed
              Fair
      value of distribution
              Gain
      on distribution
              Net
      interest expense recorded
              Reduction
      to intangible asset recordedJanuary
      10, 2007
              
              4,759,527
              $ 86
              $ 78
              $ 8
              $    (8)March
      14, 2007
              
              1,926,990
              37
              33
              4
              (4)May
      24, 2007
              
              1,725,763
              37
              43
              (6)
              -8,412,280
              $ 160
              $ 154
              $ 6
              $  (12)
 
 The
distributions described above had no cash tax consequences.
  In
accordance with the terms of the ACE Convertible Senior Notes, each of the
distributions during the year ended December 31, 2007 triggered a conversion
rate adjustment (Note 11 (a)). These changes in the conversion rate did not have
any accounting consequences.
  In
accordance with the terms of the ACE stock option plan, each distribution during
2007 triggered an adjustment to the exercise price and the number of options
outstanding (Note 15).
  Accounting
  As a
result of the distribution of units of Aeroplan Income Fund on March 14, 2007,
ACE’s ownership interest in Aeroplan was reduced to 40.1%, indirectly through
the direct interest ACE has in Aeroplan Income Fund, which holds 100% of
Aeroplan. As of the distribution date, ACE no longer consolidates the results
and financial position of Aeroplan.  On May 24, 2007, ACE’s ownership
interest in Aeroplan was further reduced to 31.1%  through a
distribution of units and on October 22, 2007 the ownership interest was again
reduced to 20.1% through a sale of units.
   24
  Notes to the
      Consolidated
      Financial Statements2007
  The
consolidated statements as at December 31, 2007 do not include the financial
position of Aeroplan. The comparative December 31, 2006 consolidated statement
of financial position included the following items:
 
 §
              cash
      and cash equivalents of $167, short-term investments of $453 and other
      current assets of $72;
 §
              long-lived
      assets of $373;
 §
              current
      liabilities of $670;
 §
              long-term
      debt of $300; and
 §
              Aeroplan
      long-term deferred revenues of
$801.
  Immediately
prior to the distribution on March 14, 2007, ACE’s net investment in Aeroplan
was negative $710, which was negative due to accumulated distributions to ACE in
excess of income and capital invested, net of fair value adjustments recorded
upon the application of fresh start reporting. Subsequent to the distribution on
March 14, 2007, ACE's 40.1% proportionate interest in the accumulated deficit of
Aeroplan LP was $284.  ACE has retained this negative investment of
$284 and reflected the amount in other long term liabilities.  As a
result, the difference between the net investment prior to and after the
distribution was recorded as a credit to Contributed Surplus in the amount of
$426.  The May 24, 2007 distribution of Aeroplan units further reduced
the negative investment in Aeroplan by $63 with a credit to contributed surplus
of $57 and a reduction to interest expense of $6 for a total credit to
contributed surplus of $483 for the year ended December 31, 2007.
  The
cash flow impact to ACE of deconsolidating Aeroplan of $231 reflects the
Aeroplan cash being removed from the consolidated statement of financial
position of ACE and is classified as a cash outflow from investing
activities.
  The
Corporation has various related party transactions after deconsolidation of
Aeroplan from ACE and these transactions are recorded at the exchange amount.
Related party trade balances arise from the provision of services, and the
allocation of employee related costs.  Refer to Note 22 Related Party
Transactions for a description of the transactions between the Corporation and
Aeroplan.
  Secondary
Offering
 
 On
October 22, 2007 the Corporation completed a secondary offering of 22.0 million
trust units of Aeroplan Income Fund at a price of $21.90 per unit, for net
proceeds of $463, resulting in a reduction to the negative investment in
Aeroplan of $76 and realized a gain on disposal of $539.  Immediately
following closing of the offering, the Corporation’s interest in Aeroplan Income
Fund represented 20.1% of units issued and outstanding.
  Aeroplan
Miles Obligation
 
 In
2001, Air Canada established Aeroplan as a limited partnership wholly owned by
Air Canada.  The Aeroplan loyalty program was previously a division of
Air Canada.
 
 Under
the Commercial Participation and Services Agreement (CPSA) between Air Canada
and Aeroplan, Air Canada retained responsibility for the 103 billion Miles to be
redeemed from accumulations up to December 31, 2001.  Aeroplan assumed
responsibility for all Miles issued beginning January 1, 2002.  On
December 31, 2001, there were 171 billion Miles outstanding of which, after
considering breakage, management estimated that 103 billion Miles would be
redeemed.
 
 In
2006, management of Air Canada and Aeroplan re-estimated the number of Miles
expected to be redeemed from accumulations up to December 31,
2001.  As a result, management of Air Canada and Aeroplan concluded
that they expected that 112 billion Miles would be redeemed compared to the
original estimate of 103 billion.  Pursuant to the terms of the CPSA,
dated June 9, 2004, as amended, the management of Air Canada and Aeroplan agreed
to further amend the terms of the CPSA.  Effective October 13, 2006,
by amendment, Air Canada assumed responsibility for the redemption of up to 112
billion Miles and, as a result, recorded a special charge of $102 for the
incremental 9 billion Miles against Operating revenues in the year ended
December 31, 2006 and increased the Aeroplan miles obligation.  This
amendment to the CPSA represented full and final settlement with Aeroplan of Air
Canada’s obligations for the redemption of pre-2002 Miles.  Aeroplan
is responsible for any redemption of Miles in excess of the re-estimated 112
billion Miles.  The amount of the additional liability was determined
by valuing the incremental Miles at fair value.
    25
  Notes to the
      Consolidated
      Financial Statements2007
 
 5.
      JAZZ
 
 Initial
Public Offering
  ACE
completed an initial public offering of the Jazz Air Income Fund on February 2,
2006. The Jazz Fund subscribed for 23.5 million units of Jazz at a price of
$10.00 per unit for net proceeds of $218, net of offering costs of $17.
Concurrent with the closing of the initial public offering, Jazz received
proceeds of $113, after fees of $2, representing the drawing under a new term
credit facility (Note 11).
  On
February 27, 2006, following the exercise of the over-allotment option by the
underwriters, the Jazz Air Income Fund issued an additional 1.5 million units at
a price of $10.00 per unit for additional net proceeds of approximately
$14.
  The
Jazz Air Income Fund is an unincorporated, open-ended trust that indirectly
holds 100% of the outstanding limited partnership units of Jazz.
  ACE
recorded a dilution gain of $220 and a non-controlling interest on the statement
of financial position of $10 as a result of the dilution of its interests in
Jazz. The dilution gain is the net proceeds of the offering in excess of ACE’s
proportionate carrying value of its investment in Jazz. In addition, a future
income tax expense of $10 was recorded.
  Distributions
  Pursuant
to the Plan (Note 4), on March 14, 2007,  ACE distributed to its
shareholders of record 25 million units of Jazz Air Income Fund units,
representing 0.219 units of Jazz Air Income Fund per Variable Voting Share,
Voting Share and Preferred Share of ACE (on an as converted basis). Based the
closing price of $8.60 per unit of Jazz Air Income Fund on the TSX on March 14,
2007, the value of the distribution was approximately $215. For the purpose of
the distribution, on March 14, 2007, ACE exchanged 25 million units of Jazz LP
into 25 million units of Jazz Air Income Fund.
  On
March 30, 2007, ACE exchanged its remaining 47,226,920 units of Jazz LP at that
time into 47,226,920 units of Jazz Air Income Fund for internal reorganization
purposes.
  On May
24, 2007, ACE made a final distribution under the Plan to its shareholders of
record 12 million units of Jazz Air Income Fund units, representing 0.105 units
of Jazz Air Income Fund per Variable Voting Share, Voting Share and Preferred
Share (on an as converted basis) of ACE. Based the closing price of $8.26 per
unit of Jazz Air Income Fund on the TSX on May 24, 2007, the distribution was
valued at approximately $99.
  The
following table summarizes the Jazz units distributed to shareholders during
2007:
  Distributions
              
              
              Jazz
      units distributedDistributed
      to common shareholders
              
              
              33,473,182Distributed
      to preferred shareholders
              
              
              3,526,81837,000,000
 
 Since
the approval of the statutory plan of arrangement in October 2006, a total of
$1,993, comprising of Jazz ($314) and Aeroplan ($1,679) (Note 4), based on unit
prices on the respective dates of distribution, has been distributed, under the
$2 billion plan.
  Distributions to Common
Shareholders
  The
distributions to holders of Variable Voting Shares and Voting Shares totaling
33,473,182 units of Jazz Air Income Fund (“Jazz units”) were non-monetary
non-reciprocal transfers to owners. Non-monetary non-reciprocal transfers to
owners are recorded at the carrying amount of the net assets transferred and do
not give rise to a gain or loss.
   26
  Notes to the
      Consolidated
      Financial Statements2007
 
 For the
Jazz units distributed, $23 was recorded as a reduction to share capital and an
increase to non-controlling interest on the consolidated statement of financial
position, representing the proportionate carrying amount of ACE’s investment in
Jazz related to the distribution to the Class A and Class B shareholders. The
distributions involved the use of future income tax assets, of which $47 related
to the distributions to the common shareholders which was recorded as a
reduction in share capital. The following table summarizes the financial
statement impact of the Jazz units distributed to Class A and Class B
shareholders:
 
 Distribution
      to
                common
      shareholders
              
              
              Jazz
      units distributed
              Reduction
      to share capital recorded
              Reduction
      to share capital due to FITMarch
      14, 2007
              
              
              22,623,690
              $  (15)
              $  (34)May
      24, 2007
              
              
              10,849,492
              (8)
              (13)33,473,182
              $  (23)
              $  (47)
 
 Distributions to Preferred
Shareholders
  The
distributions to preferred shareholders of ACE totaled 3,526,818 Jazz units.
These transactions were considered a non-reciprocal transfer to non-owners since
the holders of the Preferred Shares are not considered owners of the Corporation
for accounting purposes. The transfers are measured at fair value at the date of
distribution and results in net interest expense being recorded, which is the
fair value of each distribution less the gain recorded. The gain recorded is the
fair value of the distribution in excess of the Corporation’s proportionate
carrying value of its investment. The fair value of the distribution is based on
the closing price of the Jazz Air Income Fund units on the TSX on the day of the
distribution.
  The
Jazz units distributed to preferred shareholders resulted in net interest
expense recorded during the year and an increase to non-controlling interest as
a result of the dilution of interests. The following table summarizes the
financial statement impact of the Jazz units distributed to preferred
shareholders:
  Distribution
      to
                preferred
      shareholders
              Jazz
      units distributed
              Fair
      value of distribution
              Gain
      on distribution
              Net
      interest expense recorded
              Non-controlling
      interestMarch
      14, 2007
              
              2,376,310
              $ 21
              $ 19
              $ 2
              $  (2)May
      24, 2007
              
              1,150,508
              10
              9
              1
              (1)3,526,818
              $ 31
              $ 28
              $ 3
              $  (3)
 
 The
distributions described above had no cash tax consequences.
 
 In
accordance with the terms of the ACE Convertible Senior Notes, each of the
distributions during the year ended December 31, 2007 triggered a conversion
rate adjustment (Note 11). These changes in the conversion rate did not have any
accounting consequences.
  In
accordance with the terms of the ACE stock option plan, each distribution during
2007 triggered an adjustment to the exercise price and the number of options
outstanding (Note 15).
  Accounting
  As a
result of the distribution of units of Jazz Air Income Fund on May 24, 2007,
ACE’s ownership interest in Jazz was reduced from 58.8% to 49.0%, which is held
indirectly through the direct interest ACE has in Jazz Air Income Fund, which
holds 100% of Jazz. As of this distribution date, ACE no longer consolidates the
results of operations or financial position of Jazz, and accounts for Jazz using
the equity method of accounting.
  The
consolidated statements as at December 31, 2007 do not include the financial
position of Jazz. The comparative December 31, 2006 consolidated statement of
financial position included the following items:
 
 §
              cash
      and cash equivalents of $135, and other current assets of
      $109;
 §
              long-lived
      assets of $239;
 §
              current
      liabilities of $213;
 §
              long-term
      debt of $115; and
 §
              other
      long term liabilities of $71.
  As at
May 24, 2007, ACE’s net investment in Jazz was $48.
   27
  Notes to the
      Consolidated
      Financial Statements2007
  The
cash flow impact to ACE of deconsolidating Jazz of $138 reflects the Jazz cash
being removed from the consolidated statement of financial position of ACE and
is classified as a cash outflow from investing activities.
  The
Corporation has various related party transactions after removing Jazz from the
consolidation of ACE.  These transactions are recorded at the exchange
amount. Related party trade balances arise from the provision of
services.  Refer to Note 22 Related Party Transactions for a
description of the transactions between the Corporation and Jazz.
  Secondary
Offering
 
 On
October 22, 2007 the Corporation completed a secondary offering of 35.5 million
trust units of Jazz Air Income Fund at a price of $7.75 per unit, for net
proceeds of $263 and realized a gain on disposal of $233.  Immediately
following closing of the offering, the Corporation’s interest in Jazz Air Income
Fund represented 20.1% of units issued and outstanding.
 
 Subsequent
to December 31, 2007 ACE further reduced its ownership interest in Jazz Air
Income Fund to 9.5% (Note 24).
   28
  Notes to the
      Consolidated
      Financial Statements2007
 
 6.
      ACTS
 
 Monetization
  On
October 16, 2007, ACE sold substantially all the assets and liabilities of ACTS
LP to ACTS Aero.  As a result of the monetization of ACTS, the $200
intercompany note payable by ACTS to ACE was settled through the issue of
additional partnership units of ACTS LP to ACE.  After settlement of
certain obligations ACE received cash proceeds of $723. Subsequent to December
31, 2007, ACE received an additional $40 in cash proceeds from funds held in
escrow that was conditional upon the completion of certain supplier contracts
within specified terms. In addition, on closing Air Canada received cash
proceeds of $65, comprised of $28 for the sale of a building, $20 pursuant to
the Repair Schemes and Non-compete agreement, and $17 as repayment of a
note.  ACE realized a gain of $565 on the monetization, which includes
the funds held in escrow received subsequent to
closing.    ACE continues to own 100% of ACTS LP, which is
now a non-operating company, and ACTS Aero conducts the business previously
operated by ACTS LP.  Following the redemption of the exchangeable
share issued to a party related to Grupo TACA as discussed below and the
establishment of an initial ACTS Long Term Incentive Plan (“LTIP”), ACE holds a
23% equity interest in ACTS Aero.
  The
consolidated statement of financial position as at December 31, 2007 does not
include the financial position or results of operations of ACTS Aero, as ACTS
Aero is equity accounted for subsequent to the monetization. The comparative
December 31, 2006 consolidated statement of financial position included the
following items of ACTS:
 
 §
              cash
      and cash equivalents of $nil, and other current assets of
      $837;
 §
              long-lived
      assets of $141; and
 §
              current
      liabilities of $653.
 
 As at
October 16, 2007, ACE’s net investment in ACTS Aero was $76, subsequent to the
sale.
  The
cash flow impact to ACE of deconsolidating ACTS of $7 reflects the ACTS cash
being removed from the consolidated statement of financial position of ACE and
is classified as a cash outflow from investing activities.
  The
Corporation has various related party transactions after removing ACTS from the
consolidation of ACE.  These transactions are recorded at the exchange
amount.  Refer to Note 22 Related Party Transactions for a description
of the transactions between the Corporation and ACTS Aero.
  Acquisition
of Aeroman
  On
February 13, 2007, ACTS LP, through a wholly-owned subsidiary, acquired 80% of
Aeromantenimiento, S.A. ("Aeroman"), the aircraft maintenance division of Grupo
TACA Holdings Limited ("Grupo TACA") of El Salvador. Total consideration for
this acquisition included cash as well as a right to acquire an equity stake in
ACTS LP. The cash component of US$45 consisted of cash of $50 (US$43) on closing
and milestone payments of up to $2 (US$2) in the aggregate, funded by ACTS LP
through ACE's available cash resources.
  A Class
A non-voting redeemable share in a wholly-owned subsidiary of ACTS LP
(“exchangeable share”) was issued to Grupo TACA.  The rights attached
to the exchangeable share provide for, upon the closing of the monetization
transaction pertaining to ACTS, the exchangeable share held by Grupo TACA to be
exchanged for a variable number of shares or equity interest in ACTS. Subsequent
to the issue of the exchangeable share, ACE agreed to a transfer of Grupo TACA’s
rights to a Grupo TACA related party. The estimated fair value of
this redemption obligation was presented as a liability. As part of the
monetization process, on October 16, 2007, the exchangeable share was exchanged
for a 5% equity stake in ACTS Aero and $31 cash.  The Grupo TACA
related party can put its equity in ACTS Aero to ACE at $18 (US $18) over 12
months commencing from the date of monetization.
  
 29
  Notes to the
      Consolidated
      Financial Statements2007
  7.
      PROPERTY AND EQUIPMENT
  2007
              2006CostFlight
      equipment, including spare engines (a)
              $    5,433
              $    3,663Assets
      under capital leases (b)
              1,899
              1,813Buildings,
      including leasehold improvements
              609
              674Ground
      and other equipment
              136
              1728,077
              6,322Accumulated
      depreciation and amortizationFlight
      equipment, including spare engines
              685
              476Assets
      under capital leases (b)
              438
              285Buildings,
      including leasehold improvements
              118
              99Ground
      and other equipment
              35
              401,276
              9006,801
              5,422Purchase
      deposits, including capitalized interest (c)
              1,124
              567Property
      and equipment at net book value (d)
              $    7,925
              $    5,989
 
  (a)
              Included
      in flight equipment as at December 31, 2007 are rotable parts, including
      spare engines with a cost of $560 (2006 - $450) less accumulated
      depreciation of $121 (2006 - $70) for a net book value of $439 (2006 -
      $380).  Also included in flight equipment are 33 aircraft, which
      are leased to Jazz (Note 22) and third parties with a cost of $753 (2006 -
      $763) less accumulated depreciation of $152 (2006 - $100) for a net book
      value of $601 (2006 - $663).
  (b)
              Included
      in capital leases as at December 31, 2007 are 39 aircraft (2006 - 37) with
      a cost of $1,825 (2006 - $1,739) less accumulated depreciation of $409
      (2006 - $265) for a net book value of $1,416 (2006 - $1,474), computer
      equipment with a cost of $28 (2006 - $28) less accumulated depreciation of
      $23 (2006 - $16) for a net book value of $5 (2006 - $12) and facilities
      with a cost of $46 (2006 - $46) less accumulated depreciation $6 (2006 -
      $4) for a net book value of $40 (2006 -
$42).
  (c)
              Includes
      $867 (2006 - $287) for Boeing B777/787 aircraft, $26 (2006 - $66) for
      Empresa Brasileira de Aeronautica S.A. (“Embraer”) aircraft, $205 (2006 -
      $175) for the aircraft interior refurbishment program and $26 (2006 - $35)
      for equipment purchases and internal projects.  Refer to Note
      11(d) relating to the financing of Boeing predelivery
      payments.
  (d)
              Net
      book value of Property and equipment includes $973 (2006 - $1,137)
      consolidated for aircraft and engine leasing entities, and $123 (2006 -
      $111) consolidated for fuel facility corporations, all of which are
      consolidated under AcG-15.
  Interest
capitalized during 2007 amounted to $108 (2006 - $61) with $63 at an interest
rate of 3 month US LIBOR plus 3.0% and $5 at an interest rate of 30 day LIBOR
plus 1.14% and $40 at an interest rate of 8.34%.
  During
      2007:
  §
              The
      Corporation sold an in-service aircraft for proceeds of $23 with a book
      value of $21, resulting in a gain on sale of $2 (loss of $2 net of
      tax).
 §
              The
      Corporation sold a building to ACTS Aero for proceeds of $28 which was
      equal to the carrying value of the
asset.
 §
              A CRJ-100 aircraft owned by Air
      Canada and leased to Jazz was damaged beyond repair.  As a
      result of insurance proceeds of $21, Air Canada recorded a gain on
      disposal of $14 ($10 net of
tax).
 §
              The Corporation sold one of its
      commercial real estate properties for net proceeds of $42 with a carrying
      value of $37, resulting in a gain on sale of $5 ($4 net of
      tax).
 §
              The
      Corporation sold 18 parked aircraft for proceeds of $2 with a nil book
      value, resulting in a gain on sale of $2 ($1 net of
  tax).
 
  
 30
  Notes to the
      Consolidated
      Financial Statements2007
  During
2006 the Corporation sold one of its buildings for proceeds of $40 with a
carrying value of $35. The gain on sale of $5 was deferred in these consolidated
financial statements as a result of the leaseback of a portion of the property
by the Corporation. The deferred gain is being amortized into income over the
term of the leaseback transaction. The Corporation recorded an impairment
loss of $7 on one of its buildings.
    31
  Notes to the
      Consolidated
      Financial Statements2007
 8.
      DEFERRED CHARGES
 
 2007
              2006Aircraft
      lease payments in excess of rent expense
              Note
      2 (Y)
              $       47
              $      83Financing
      costs
              
              4
              33$       51
              $    116
 
  
 9.
      INTANGIBLE ASSETS
  2007
              2006Indefinite
      life assetsInternational
      route rights and slots
              $    192
              $    430Air
      Canada trade name
              174
              393Aeroplan
      trade name
              -
              75Other
      marketing based trade names
              15
              50381
              948Finite
      life assetsAeroplan
      contracts
              -
              291Star
      Alliance membership
              92
              158Other
      contract and customer based
              153
              257Technology
      based
              186
              196431
              902Accumulated
      depreciation and amortizationAeroplan
      contracts
              -
              (40)Star
      Alliance membership
              (27)
              (22)Other
      contract and customer based
              (81)
              (90)Technology
      based
              (57)
              (55)(165)
              (207)Finite
      life assets, net
              266
              695$    647
              $  1,643
 As a
result of recognizing the benefit of future income tax assets that existed at
fresh start, and for which a valuation allowance was recorded, intangible assets
were reduced on a pro-rata basis by $595 (2006 - $733), including the impact of
reversing $530 from the income tax valuation allowance as described in Note
12.  In addition, amortization of intangible assets in 2007 amounted
to $51 (2006 - $95).
  The
carrying value of intangible assets includes nil (2006 - $369) related to
Aeroplan which ceased to be consolidated effective March 14, 2007 (Note 4); nil
(2006 - $5) related to Jazz which ceased to be consolidated under AcG-15
effective May 24, 2007 (Note 5); and nil (2006 - $71) related to ACTS which
ceased to be consolidated effective October 16, 2007 (Note 6).
 
  32
 
 Notes to the
      Consolidated
      Financial Statements2007
 
 10.
      DEPOSITS AND OTHER ASSETS
 
 2007
              2006Aircraft
      related deposits (a)
              
              $    150
              $    172Restricted
      Cash (b)
              
              84
              133Deposit
      related to the Pension and Benefits Agreement
              note
      22
              101
              -Equity
      Investments (c)
              
              86
              -Investment
      in US Airways (d)
              
              -
              9Asset
      backed commercial paper (e)
              
              29
              -Other
      Deposits
              
              56
              -Other
              
              21
              9$    527
              $    323
 
 (a)
              The
      amount of deposits with lessors for the lease of aircraft and flight
      simulators.
 
 (b)
              Restricted
      cash relates to funds on deposit with various financial institutions as
      collateral for letters of credit and other
  items.
 
 (c)
              Equity
      investments include Jazz Air Income Fund $14 (Note 5) and ACTS Aero $72
      (Note 6).
 
 (d)
              During
      2007 ACE disposed of the remaining 0.5 million shares of its holding in US
      Airways Group, Inc. (“US Airways”).  The net proceeds from the
      sale transaction amounted to $16.  The Corporation has recorded
      a gain of $6 (net of tax of $2) as a result of this
      transaction.  The fair value change recorded during the year,
      prior to disposal amounted to a loss of $13 (net of tax of $3) recorded in
      OCI.  The amount of OCI and the amount of AOCI reclassified to
      income on the realized gains on US Airways shares was $6 (net of tax of
      $2).
  During
2006 ACE disposed of 4.5 million shares of its holding in US Airways. The net
proceeds from the sale transactions amounted to $232. The Corporation recorded a
pre-tax gain of $152, $126 after tax, during 2006 as a result of these
transactions.
 
 (e)
              Air
      Canada holds $37 ($29 net of a fair value adjustment) in non-bank
      sponsored ABCP which has been recorded in Deposits and other
      assets.  These investments, which were scheduled to mature
      during the third quarter 2007, were previously recorded in Cash and
      cash-equivalents and the transfer to Deposits and other assets is
      reflected as an investing activity on the Consolidated statement of cash
      flows.  An agreement in principle to restructure the ABCP
      investments was approved by the Pan-Canadian Committee for Third Party
      Structured ABCP (“Committee”) on December 23, 2007.  The
      approval of the restructuring, subject to a vote by all investors, is
      anticipated to occur by March 2008.  Under the terms of the
      restructuring, all of the ABCP would be exchanged for longer-term notes
      that will match the maturity of the underlying assets in the proposed
      structure.  Air Canada is not accruing interest on these
      investments.
  During
2007, Air Canada recorded a charge of $8 ($5 after tax) in non-operating income
(expense).  The charge is based on a number of assumptions as to the
fair value of the investments including factors such as estimated cash flow
scenarios and risk adjusted discount rates.  The assumptions used in
estimating the fair value of the investments are subject to change, which may
result in further adjustments to non-operating results in the
future.
  
 33
  Notes to the
      Consolidated
      Financial Statements2007
 11.
      LONG-TERM DEBT AND CAPITAL LEASES
  
 Final
      Maturity
              Stated
      Interest Rate
              2007
              2006ACE:Convertible
      Senior Notes (a)
              2035
              4.25
              $      273
              $      263Air
      Canada:Embraer
      aircraft financing (b)
              2017-2021
              6.61-8.49
              1,138
              776Boeing
      aircraft financing (c)
              2019
              5.13-5.69
              647
              -Boeing
      predelivery payments (d)
              2008-2013
              6.16
              521
              -Conditional
      sales agreements (e)
              2019
              7.74-7.97
              149
              184Lufthansa
      cooperation agreement (f)
              2009
              6.50
              25
              44GE
      loan (g)
              2015
              10.58
              38
              48Revolving
      credit facility (h)
              
              
              -
              -Canadian
      Regional Jet (i)
              2012
              6.43
              33
              -Aeroplan:Credit
      facilities (j)
              
              
              -
              300Jazz:Senior
      secured credit facility (k)
              
              
              -
              115Other
              
              
              -
              5Direct
      Corporation debt
              
              
              2,824
              1,735Air
      Canada:
              
              
              -Aircraft
      and engine leasing entities - debt (l)
              
              
              771
              1,051Fuel
      facility corporations - debt (m)
              
              
              125
              59Debt
      consolidated under AcG-15
              
              
              896
              1,110Air
      Canada:Capital
      lease obligations (n)
              
              
              972
              1,281Total
      debt and capital leases
              
              
              4,692
              4,126Current
      portion
              
              
              (686)
              (367)Long-term
      debt and capital leases
              
              
              $    4,006
              $    3,759The
      Stated Interest Rate in the table above is the rate as of December 31,
      2007
 
 Principal
repayment requirements as at December 31, 2007 on long-term debt and capital
lease obligations, and aircraft, engine and fuel facility debt consolidated as
variable interest entities under AcG-15 are as follows:
 2008
              2009
              2010
              2011
              2012
              Thereafter
              TotalConvertible
      Senior Notes
              $    273
              $         -
              $         -
              $         -
              $         -
              $            -
              $       273Other
      Direct Corporation debt
              160
              152
              141
              153
              166
              1,779
              2,551Debt
      consolidated under AcG-15
              105
              51
              100
              288
              73
              279
              896Capital
      lease principal obligation
              148
              80
              83
              84
              132
              445
              972Total
              $    686
              $    283
              $    324
              $    525
              $    371
              $    2,503
              $    4,692
 
 
 (a)
              During
      2005 ACE issued $330 of Convertible Senior Notes due 2035 (“Convertible
      Notes”) for net proceeds of $319. For accounting purposes, the Convertible
      Notes are presented as a compound instrument. At the date of issuance, the
      value ascribed to the holders’ conversion option, which is presented as
      equity, was $94 less allocated fees of $2; the value ascribed to the
      financial liability was $236. The financial liability was originally
      calculated by discounting the stream of future payments of interest and
      principal at the prevailing rate for a similar liability that does not
      have an associated conversion feature. All Convertible Notes have been
      reclassified to current liabilities as at December 31,
      2007.  Consistent with the reclassification of the convertible
      notes to the current portion of long-term debt, an adjustment to the
      amortized cost carrying value of the liability was recorded resulting in
      an increase to the liability of $2 and a charge to interest expense of
      $2.  Refer to Note 20 for fair value of convertible notes at
      December 31, 2007.
  The
Convertible Notes bear interest at a rate of 4.25% per annum payable
semi-annually in arrears on June 1 and December 1 in each year commencing
December 1, 2005. Holders may convert their Convertible Notes into Class B
Voting Shares (if the holder is Canadian) or into Class A Variable Voting Shares
(if the holder is not a Canadian) prior to maturity based on an initial
conversion rate of 20.8333 Shares per $1,000.00 principal
    34
  Notes to the
      Consolidated
      Financial Statements2007
  amount
of Convertible Notes. Upon notice of conversion, ACE will have the option to
deliver cash, shares or a combination of cash and shares for the Convertible
Notes surrendered.  Holders converting their Notes will not receive
any payment upon conversion representing accrued but unpaid interest on such
Notes. The amount of cash to be delivered per Convertible Note, will be
determined by multiplying the conversion rate by the average closing price
(defined as the weighted average, by volume, of the reported last sale price of
each class of shares) of the shares on the Toronto Stock Exchange (“TSX”) for
the ten consecutive trading days ending on the third trading day following the
date fixed for redemption.  By delivering the amount of cash and/or
the number of Shares issuable on conversion, the Corporation will be deemed to
have satisfied its obligation to pay the principal amount of the Convertible
Notes and its obligation to pay accrued and unpaid interest, attributable to the
period from the most recent interest payment date through the conversion date
(which amount will be deemed paid in full rather than cancelled, extinguished or
forfeited).
  In
connection with the distributions of units of Aeroplan Income Fund and Jazz Air
Income Fund to the shareholders of ACE (Notes 4 and 5), the conversion rate of
the 4.25% Convertible Senior Notes, due 2035 (“Convertible Notes”) to Class A
variable voting shares (if the holder is not a Canadian) or Class B voting
shares (if the holder is Canadian) per $1,000 principal amount of Convertible
Notes, has been adjusted to 37.6879 as at December 31,
2007.  Subsequent to December 31, 2007 the conversion rate was further
adjusted to 39.0341 (Note 24).  Adjustments were determined in
accordance with the terms of the indenture governing the Convertible
Notes.
  During
2007, Convertible Notes with a face value of $6 were converted at the option of
the holder and settled for cash of $6, reducing the liability and equity
portions of the notes by $5 and $1 respectively.   The gain
realized on conversion was negligible.  Subsequent to December 31 a
further $1 Convertible notes were converted and settled for cash.
  At any
time on or after June 6, 2008, ACE may redeem all or a portion of the
Convertible Notes at a redemption price equal to 100% of the principal amount of
the Convertible Notes, plus accrued interest. Holders may require ACE to
purchase all or a portion of the Convertible Notes on June 1, 2010; June 1,
2015; June 1, 2020; June 1, 2025 and June 1, 2030 at a purchase price equal to
100% of the principal amount of the Notes to be purchased, plus accrued and
unpaid interest. Upon specified change of control events, holders of Convertible
Notes will have the option to require ACE to purchase all or any portion of the
Convertible Notes at a price equal to 100% of the principal amount of the
Convertible Notes to be purchased, plus accrued and unpaid
interest.
  ACE
may, at its option and subject to certain conditions, elect to satisfy its
obligation to repay all or any portion of the principal amount of the
Convertible Notes that are to be redeemed, purchased or that are to be repaid at
maturity, by issuing and delivering Class A Variable Voting Shares (if the
holder is not a Canadian) and Class B Voting Shares (if the holder is Canadian).
The number of Shares a holder will receive in respect of each Convertible Note
will be determined by dividing the principal amount of the Convertible Notes
that are to be redeemed, purchased or repaid at maturity, as the case may be,
and that are not paid in cash, by 95% of the average closing price (defined as
the weighted average, by volume, of the reported last sale price of each class
of shares) of the shares on the Toronto Stock Exchange (“TSX”) for the ten
consecutive trading days ending on the third trading day following the date
fixed for redemption, purchase or maturity date, as the case may
be.
  All
Convertible Notes have been reclassified to current liabilities as at December
31, 2007.
  (b)
              Embraer
      aircraft financing amounts to US$1,151 as at December 31, 2007 (US$666 as
      at December 31, 2006).  Principal and interest is repaid
      quarterly until maturity.  The loan is secured by the 57
      delivered Embraer aircraft, including 2005 to 2007 deliveries, with a
      carrying value of $1,651.
  (c)
              Boeing
      aircraft financing amounts to US$655 as at December 31, 2007, which is
      financed under loan guarantee support provided by the Export-Import Bank
      of the United States (“EXIM”), as described below.  Principal
      and interest is repaid quarterly until maturity.  The loan is
      secured by the 7 delivered aircraft with a carrying value of
      $992.
  On
April 19, 2007, the Corporation received a final commitment for loan guarantee
support, subject to the fulfillment of certain terms and conditions, from EXIM
covering seven Boeing 777 aircraft under the Corporation’s purchase agreement
with Boeing (the “Boeing Purchase Agreement”), to be delivered in
2007.  During 2007, the Corporation took delivery of eight Boeing 777
aircraft, seven of which were acquired under the Boeing Purchase Agreement and
financed under the loan guarantee support provided
   35
  Notes to the
      Consolidated
      Financial Statements2007
  by
EXIM, the other one being subject to an operating lease agreement with
International Lease Finance Corporation (“ILFC”).
  (d)
              On
      October 30, 2007, Air Canada entered into an agreement with a syndicate of
      banks for the financing of pre-delivery payments (“PDP”) for 10 of the 16
      Boeing B777 aircraft contemplated in the Boeing Purchase
      Agreement.  The PDP financing is a series of loans that are
      aircraft specific with a maximum aggregate commitment of up to $568
      (US$575).  The PDP loans have a term of five years, but may be
      prepaid upon the delivery of the aircraft without penalty.  The
      Corporation drew $533 (US$540) in October 2007.  Air Canada
      prepaid in November 2007, the PDP loan of $64 (US$65) on the first Boeing
      777 delivered under the PDP financing agreement.   In
      addition, Air Canada has served notice to the PDP syndicate that it will
      be repaying the PDP loans on delivery of the second through eighth
      aircraft.  Air Canada’s intent is to prepay all PDP loans upon
      delivery of the relevant aircraft, using the committed long-term aircraft
      financing for the aircraft to be delivered.  The last aircraft
      in this PDP financing is currently scheduled for delivery in November
      2008, at which time, Air Canada expects to have fully repaid the PDP
      loans.  At year-end 2007, the balance outstanding on the PDP
      loans was $521 (US$528), which includes two additional draws of $26
      (US$26) each.  The long-term financing is included within
      Long-term debt and capital leases within the Consolidated statement of
      financial position.  The year to date capitalized interest
      relating to this financing is $5 at an interest rate of 30 day LIBOR plus
      1.14% (6.16% as at December 31, 2007).  As the loans are not due
      until 2013, the principal repayment is shown in the thereafter amount in
      the table
above.
  (e)
              US$151
      principal outstanding on acquisitions of two A340-500 aircraft financed
      through conditional sales agreements. Principal and interest is paid
      quarterly until maturity in 2019. The purchase price instalments bear
      interest at a three month LIBOR rate plus 2.9% (7.74% - 7.97% as at
      December 31, 2007 and 8.27% as at December 31, 2006).  The
      carrying value of the two A340-500 aircraft provided as security under the
      conditional sales agreements is $265 as at December 31,
    2007.
  (f)
              US$25
      principal outstanding to mature in 2009, with semi-annual repayments, at a
      fixed interest rate of 4.50% plus an annual 2.0% guarantee
      fee.
  (g)
              US$38
      principal outstanding to mature in 2015, with quarterly repayments, at a
      floating interest rate equal to the six month LIBOR rate plus 5.75%
      pre-payable on any interest payment date after December 23,
      2007.  The next interest payment date is March 20,
      2008.  The debt is secured by certain flight training equipment
      with a current carrying value of
$47.
  (h)
              The
      revolving credit facility is a $400 senior secured revolving credit
      facility (the "Credit Facility") with a three-year term. The Credit
      Facility has a three year term that can be extended at Air Canada’s option
      for additional one-year periods on each anniversary of the closing of the
      Air Canada IPO, subject to prior approval of Lenders holding no less than
      two thirds of the total commitments under the Credit Facility. The total
      amount available for borrowing under the Credit Facility is subject to a
      borrowing base restriction based on certain percentages of the values of
      eligible accounts receivable and eligible real estate of Air Canada. The
      Credit Facility is secured by a first priority security interest and
      hypothec over the present and after-acquired personal property of Air
      Canada, subject to certain exclusions and permitted liens, and by a first
      priority charge and hypothec over certain owned and leased real property
      of Air Canada. Air Canada's obligations are guaranteed by 1209265 Alberta
      Ltd., a subsidiary of Air Canada, which provides a first priority security
      interest over its present and after-acquired personal property, subject to
      certain exclusions and permitted liens, as security for its guarantee
      obligations. The Credit Facility contains customary representations and
      warranties and is subject to customary terms and conditions (including
      negative covenants, financial covenants and events of default). The
      interest rate margin ranges from LIBOR plus 2.25% to 3.25% or prime plus
      1.25% to 2.25% (based on Air Canada's earnings before interest, taxes,
      depreciation, amortization and obsolescence and aircraft rent). As at
      December 31, 2007, no amount was drawn under this
  facility.
  (i)
              During
      2007, Air Canada refinanced five Canadair Regional Jet (“CRJ”)
      aircraft.  The refinancing included a payment of other
      obligations under the leasing arrangement to third parties of
      $36.  During 2007 the debt of $9 relating to one of the CRJ
      aircraft was repaid.   As at December 31, 2007, the
      principal outstanding is $33 on the four CRJ aircraft. Principal and
      interest are paid quarterly to maturity in 2012. The financing bears
      interest at a floating rate of the 3 month Canadian Banker’s Acceptance
      rate plus 1.7%.  The loan is secured by the five delivered
      aircraft with a carrying value of
$29.
   36
  Notes to the
      Consolidated
      Financial Statements2007
  (j)
              As
      of March 14, 2007 ACE no longer consolidates the results and financial
      position of Aeroplan (see Note 4).
  As
      at December 31, 2006 Aeroplan reported senior secured credit facilities in
      the amount of $475. The credit facilities consisted of a $300 (or the U.S.
      dollar equivalent thereof) term facility (the “Term Facility”), a $100 (or
      the U.S. dollar equivalent thereof) acquisition facility (the “Acquisition
      Facility”) and a $75 (or the U.S. dollar equivalent thereof) revolving
      term facility (the “Revolving Term
Facility”).
  The
Term Facility and the Acquisition Facility mature on June 29, 2009, or earlier
at the option of Aeroplan, and bear interest at rates ranging from Canadian
prime rate and U.S. base rate to Canadian prime rate and U.S. base rate plus
0.75% and the Bankers’ Acceptance rate and LIBOR plus 1.0% to 1.75%. At December
31, 2006, borrowings under the Term Facility were in the form of Bankers’
Acceptances with a 90 day term and an effective interest rate of 5.3%. The Term
Facility was drawn in order to fund a portion of the $400 Aeroplan Miles
Redemption Reserve, included in Cash and cash equivalents and Short-term
investments. The remaining $100 was funded from the proceeds of the Aeroplan
offering during 2005. As at December 31, 2006, no amounts were drawn under the
Acquisition Facility.
  Borrowings
under the Aeroplan credit facilities were secured by substantially all the
present and future assets of Aeroplan, subject to a merchant services agreement
with First Data Loan Company, Canada that included a guarantee to fulfill
obligations related to airline and tour tickets sold in advance and charged to
the credit cards processed under the agreement. As at December 31, 2006, the
maximum exposure related to this guarantee was estimated to be $215 and would
have ranked ahead of the security granted under the credit facilities, which was
included in the Advance ticket sales liability.
  The
terms of the New Credit Facilities included certain covenants. The continued
availability of the credit facilities were subject to Aeroplan’s ability to
maintain certain leverage, debt service and interest coverage covenants, as well
as other affirmative and negative covenants.
  (k)
              As
      of May 24, 2007 ACE no longer consolidates the results of operations and
      assets and liabilities of Jazz (see Note
5).
  At December 31, 2006, Jazz
      reported senior secured syndicated credit facility in the amount of $150
      (Note 5). On closing of the Jazz IPO, $115 was drawn under the credit
      facility ($113 net of fees). The facility bears interest at floating rates
      and had a three year term maturing in 2009. The outstanding credit
      facility was secured by substantially all the present and future assets of
      Jazz. Jazz had entered into swap agreements with third parties with a
      notional value of $115 to receive floating rates and pay fixed rates of
      7.09%.
  (l)
              Air
      Canada has entered into aircraft and engine lease transactions with
      several special purpose entities that qualify as VIEs. The debt has a
      weighted average effective interest rate of approximately 8% (2006 - 8%).
      These aircraft and engines have a carrying value of $973 and are charged
      as collateral against the debt by the owners thereof. The creditors under
      these leasing arrangements have recourse to the Corporation, as lessee, in
      the event of default or early termination of the lease. Aircraft related
      debt amounting to US$780 ($771) [2006 - US$902 ($1,051)] is summarized as
      follows:
 Final
      Maturity
              2007
              2006Canadian
      Regional Jet
              2010-2011
              $    218
              $     316Boeing
      767-300
              2011-2016
              163
              211Engines
              2008
              54
              71Airbus
      319
              2011-2014
              215
              304Airbus
      321
              2017
              121
              149Total
              
              $    771
              $  1,051
 
 (m)
              Under
      AcG-15, Air Canada is the primary beneficiary of certain of the Fuel
      Facility Corporations in Canada. The debt is comprised of bankers’
      acceptances with interest rates ranging from 5.72% - 6.93%, bank loans at
      prime plus 0.25% to prime plus 1.5%, and bonds payable with an interest
      rate of 5.09%.  $110 of debt is due in 2032 with equal
      semi-annual payments of principal and interest.  The remaining
      debt has varying maturities.  The debt is secured by a general
      security agreement covering all assets of the Fuel Facility
      Corporations.  The carrying value of the fuel facilities debt is
      $123 as at December 31, 2007.
  (n)
              Capital
      lease obligations, related to computer equipment, facilities and 39
      aircraft, total $972 ($71 and US$912) [2006 total $1,281 ($80 and
      US$1,030)]. The debt has a weighted average effective interest rate
   37
  Notes to the
      Consolidated
      Financial Statements2007
  of
approximately 8% and final maturities range from 2008 to 2027. During 2007 Air
Canada recorded interest expense on capital lease obligations of $96 (2006 -
$101).
  Certain
aircraft lease agreements contain a fair value test, beginning on July 1, 2009,
and annually thereafter until lease expiry. This test relates to 26 aircraft
under lease of which 23 are accounted for as capital leases. Under the test, the
Corporation may be required to prepay certain lease amounts, based on aircraft
fair values, as of the date of the test. Any amounts prepaid would be recorded
as a reduction of the lease obligation.  Air Canada contracts with
certain third parties to provide residual value support for certain
aircraft.  If Air Canada is required under the loan to value test to
prepay lease obligations, these amounts are recoverable from the third party
residual value support provider upon lease expiry to the extent that the
adjusted obligation taking into account prepayments is less than the residual
value support.  The maximum amount payable on July 1, 2009, assuming
the related aircraft are worth nil, is $722 (US$731). This amount declines over
time to nil upon lease expiry.  As Air Canada does not expect to have
to prepay any amounts based upon expectations of aircraft fair values into the
future, the amortized cost of these capital lease obligations reflects the
scheduled payments over the term to final maturity.
  As at
December 31, 2007, obligations under capital leases for future minimum lease
payments are as follows:
  2008
              $    2232009
              1472010
              1422011
              1362012
              177Thereafter
              569Total
      minimum lease payments
              1,394Less
      amount representing interest
              (422)Total
      obligation under capital leases
              $    972
 
 The
above minimum lease payments include residual value guarantees, except for those
for which the Corporation has obtained residual value support.
  Interest
paid on long-term debt and capital lease obligations in 2007 by the Corporation
was $281 (2006 - $273).
   38
  Notes to the
      Consolidated
      Financial Statements2007
  
 12.
      FUTURE INCOME TAXES
 
 The
following income tax related amounts appear in the Corporation’s consolidated
statement of financial position:
 
 Asset
              2007
              2006Future
      income tax asset recorded in current assets (a)
              $    200
              $       584Future
      income tax asset (a)
              -
              336$    200
              $       920Liability
              2007
              2006Current
      tax payable (b)
              $         -
              $    (345)Long-term
      tax payable (b)
              (10)
              -Future
      income tax liability (b)
              (50)
              (136)$    (60)
              $    (481)
 
 
 a)
FUTURE INCOME TAX ASSETS
  As at
December 31, 2007, the Corporation has determined that it is more likely than
not that certain future income tax assets of $200 will be realized through a
combination of future reversals of temporary differences and taxable
income.  Also, the Corporation has determined that it is more likely
than not that future income tax assets of $890 are not recoverable and continue
to be offset by a valuation allowance. However, the future tax deductions
underlying the future tax assets remain available for use in the future to
reduce taxable income.
  In the
year, a reversal of the valuation allowance of $621 was recorded.  Of
that amount $530 was recorded as a reduction of intangible assets (on a pro-rata
basis) based on the current carrying value of future income tax assets that
existed at fresh start and $91 as a recovery of income tax in the consolidated
statement of operations for those future income tax assets arising after fresh
start.
  During
2007, future income tax assets of Air Canada of $345 (see below) were utilized
to recover a current tax payable of the same amount. Through the distribution
and secondary offering of Aeroplan units, the Corporation realized $123 and $306
of future income tax assets that were respectively recorded as a future income
tax expense and as a reduction to share capital (refer to Note 4). In addition,
through the distribution and secondary offering of Jazz units, the Corporation
realized $52 and $47 of future income tax assets that were respectively recorded
as a future income tax expense and as a reduction to share capital (refer to
Note 5).  The Corporation realized future income tax assets of $82 in
the monetization of ACTS (refer to Note 6).  In 2006, a future income
tax expense of $59 was recorded in equity related to the ACE distribution of
Aeroplan Units.
  Refer
to Note 20 for future income taxes recorded in other comprehensive income
related to fuel derivatives designated under hedge accounting.
  b)
TAXES PAYABLE AND FUTURE INCOME TAX LIABILITY
  As part
of a tax loss utilization strategy that was planned in conjunction with the
initial public offering of Air Canada and corporate restructuring, a current tax
payable of $345 was created in 2006. This tax payable arose upon a transaction
to transfer tax assets from Air Canada to ACE. This tax payable was recoverable
from future income tax assets of Air Canada, and was settled in 2007. The Air
Canada segment recorded interest expense of $6 due on the tax balance prior to
its recovery. This amount was recorded in Current income taxes on the
consolidated statement of operations.
  In
2007, Air Canada recorded a Current income tax expense of $10 resulting from the
Federal and Ontario harmonization of corporate taxes.  Air Canada will
have a cash tax payable of $10 that will be payable over a five year period
beginning in 2009.  This amount is included in Other long-term
liabilities.
   39
  Notes to the
      Consolidated
      Financial Statements2007
  It has
been assumed that certain intangibles and other assets with nominal tax cost and
a carrying value of approximately $381, have indefinite lives and accordingly,
the associated future income tax liability is not expected to reverse until the
assets are disposed of or become amortizable, resulting in the reporting of a
future income tax liability of $50.
  2007
              2006Future
      tax assetsLoss
      carryforwards
              $      80
              $    430Post-employment
      obligations
              556
              685Accounting
      provisions not currently deductible for tax
              129
              181Tax
      basis of capital over book basis
              183
              271Investments
      in Aeroplan and Jazz
              195
              359Eligible
      capital expenditures
              2
              28Unearned
      revenues
              13
              431Intangible
      assets
              -
              102Other
              69
              61Total
      future tax assets
              1,227
              2,548Future
      tax liabilitiesIntangible
      assets
              78
              220Other
              109
              33Total
      future tax liabilities
              187
              253Net
      future tax assets
              1,040
              2,295Less
      valuation allowance
              (890)
              (1,511)Net
      recorded future income tax asset
              $    150
              $    784
 
  The
reconciliation of income tax attributable to continuing operations, computed at
the statutory tax rates, to income tax expense is as follows:
  2007
              2006Provision
      based on combined federal and provincial rates
              $    683
              $    184Non-taxable
      portion of capital gains
              (36)
              (24)Non-deductible
      expenses
              35
              35Non-taxable
      dilution gain
              -
              (67)Non-taxable
      capital gain on distribution and disposal of investments
              (212)
              -Non-controlling
      interest
              38
              -Effect
      of tax rate changes on future income taxes
              (33)
              (28)Effect
      of statutory tax rates substantively enacted during the
    year
              76
              82Reduction
      in income tax expense arising from the recognition of a previously
      unrecognized tax loss
              -
              (16)Other
              16
              25567
              191Valuation
      allowance (refer to a) above)
              (91)
              (82)Provision
      for income taxes
              $    476
              $    109
 
 Significant
components of the provision for income taxes attributable to continuing
operations are as follows:
  2007
              2006Current
      tax expense
              $      15
              $        7Future
      income tax expense relating to temporary differences
              509
              146Future
      income tax expense from tax rate changes
              43
              54Reduction
      in income tax expense arising from the recognition of a previously
      unrecognized tax loss
              -
              (16)Valuation
      allowance
              (91)
              (82)Provision
      for income taxes
              $    476
              $    109
 
 
 40
  Notes to the
      Consolidated
      Financial Statements2007
 
 Taxes
paid in 2007 by the Corporation were $13 (2006 - $1).
  The
balances of tax attributes as at December 31, 2007, namely the balances of
non-capital loss carry forwards, vary amongst different taxing jurisdictions.
The following are the Federal tax loss expiry dates:
  Tax
      Losses2010
              $        82014
              162015
              852026
              22027
              90$    201
 
 There
are $61 of net capital losses that have no expiry date.
   41
  Notes to the
      Consolidated
      Financial Statements2007
  
 13.
      PENSION AND OTHER BENEFIT
LIABILITIES
 
 Air
Canada maintains several defined benefit and defined contribution plans
providing pension, other post-retirement and post-employment benefits to its
employees, including those employees of Air Canada who are contractually
assigned to work at ACE, Aeroplan and ACTS Aero.
  Air
Canada is the administrator and sponsoring employer of ten Domestic Registered
Plans ("Domestic Registered Plans") under the Pension Benefits Standard Act,
1985 (Canada). The US plan, UK plan and Japan plan are international plans
covering employees in those countries. In addition, Air Canada maintains a
number of supplementary pension plans, which are not registered. The defined
benefit pension plans provide benefits upon retirement, termination or death
based on the member's years of service and final average earnings for a
specified period.
  Jazz
also maintains its own defined benefit and defined contribution plans, providing
pension benefits to most of its employees. These consolidated financial
statements include the consolidation of Jazz operations up to May 24, 2007 and
from that point the investment ACE has in Jazz is accounted for using the equity
method.
  The
other employee benefits consist of health, life and disability. These benefits
consist of both post-employment and post-retirement benefits. The
post-employment benefits relate to disability benefits available to eligible
active employees, while the post-retirement benefits are comprised of health
care and life insurance benefits available to eligible retired
employees.
  Certain
Air Canada employees are contractually assigned to ACTS Aero or Aeroplan. These
employees are members of Corporation-sponsored defined benefit pension plans and
also participate in Corporation-sponsored health, life and disability future
benefit plans. These consolidated financial statements include all of the assets
and liabilities of all Corporation-sponsored plans. The employee benefit expense
in these consolidated financial statements includes the expenses for all
employees participating in the plans less a cost recovery which is charged to
the related parties for those employees assigned.  The cost recovery
includes current service costs for pensions along with their portion of
post-employment and post-retirement benefits, based on the actuarial calculation
for their specific employee group.  This cost recovery amounted to $10
for the year ended December 31, 2007.
  The
measurement date used for financial reporting on the pension and other benefit
obligations is November 30.
  As described in Note 22, Air Canada and
ACTS Aero are parties to a Pension and Benefits Agreement covering the future
transfer of certain pension and benefit assets and obligations to ACTS
Aero.
   42
  Notes to the
      Consolidated
      Financial Statements2007
  Benefit
Obligation and Plan Assets
  The
following tables present financial information related to the changes in the
pension and other post-employment benefits plans:
  Pension
      Benefits
              Other
      Employee Future Benefits2007
              2006
              2007
              2006Change
      in benefit obligationBenefit
      obligation at beginning of year
              $   13,235
              $   12,921
              $      966
              $    940Current
      service cost
              254
              254
              69
              77Interest
      cost
              649
              640
              49
              48Employees'
      contributions
              88
              89
              -
              -Benefits
      paid
              (648)
              (627)
              (51)
              (60)Other
      termination benefits
              2
              -
              -
              -Actuarial
      (gain) loss
              (1,278)
              (74)
              (119)
              (38)Deconsolidation
      of Jazz
              (100)
              -
              -
              -Foreign
      exchange
              (52)
              32
              (15)
              (1)12,150
              13,235
              899
              966Change
      in plan assetsFair
      value of plan assets at beginning of year
              11,858
              10,421
              8
              14Actual
      return on plan assets
              197
              1,493
              -
              1Employer
      contributions
              382
              455
              43
              47Employees'
      contributions
              88
              89
              -
              -Benefits
      paid
              (648)
              (627)
              (51)
              (54)Deconsolidation
      of Jazz
              (81)
              -
              -
              -Foreign
      exchange
              (49)
              27
              -
              -11,747
              11,858
              -
              8Deficit
      at end of year
              403
              1,377
              899
              958Employer
      contributions after measurement date
              (7)
              (7)
              (5)
              (6)Unrecognized
      net actuarial gain (loss)
              497
              (221)
              149
              46Valuation
      allowance against accrued benefit
              1
              -
              -
              -Net
      benefit obligation
              $       894
              $     1,149
              $    1,043
              $    998Weighted
      average assumptions used to determine the accrued benefit
      liabilityDiscount
      rate
              5.75%
              5.00%
              5.75
      - 6.00%
              5.00
      - 5.50%Rate
      of compensation increase (a)
              2.50%
              2.50%
 
  (a)
              As
      a result of pay awards during 2006, a rate of compensation increase of
      1.75% was used for years 2006 to 2008 in determining the net benefit
      obligation for the pension plan and 2.5% for the remaining
      years.
  Under
the terms of the domestic registered and supplementary plans, there is no
indexation provided after January 1, 2007.
 
 The
pension benefit deficit of only those plans that are not fully funded at the end
of the year by plan is as follows:
 2007
              2006Domestic
      registered plans
              $      35
              $       556US,
      UK, and Japan
              17
              55Supplementary
      plans
              665
              766$    717
              $    1,377
 
 The net
deficit, on an accounting basis, at December 31, 2007 for pension benefits was
$403 compared to $1,377 at December 31, 2006. The decrease in the accounting
deficit is mainly the result of an increase in the discount rate and funding of
past service employer contributions of $134, offset by a negligible return on
plan assets.
   43
  Notes to the
      Consolidated
      Financial Statements2007
  The net
benefit obligation is recorded in the statement of financial position as
follows:
 2007
              2006Pension
      benefits
              $       894
              $    1,149Other
      employee future benefits
              1,043
              998Net
      benefit obligation
              1,937
              2,147Current
      portion
              (113)
              (271)Pension
      and other benefits liability
              $    1,824
              $    1,876
 
 The
current portion of Pension benefits represents past service contributions for
the Domestic Registered Plans, scheduled to be paid during 2008 while the
current portion of Other employee future benefits is an estimate of the claims
to be incurred during 2008. The current portion is included in Accounts payable
and accrued liabilities.
  Total
cash payments for 2007, consisting of cash contributed by Air Canada to its
defined benefit plans, cash payments to beneficiaries for post-employment and
post-retirement plans, and cash contributed to its defined contribution plans
were $428 (2006 - $520).
  Pension
and Other Employee Future Benefit Expense
  The
Corporation has recorded net defined benefit pension and other employee future
benefits expense as follows:
  Pension
      Benefits
              Other
      Employee Future Benefits2007
              2006
              2007
              2006Components
      of Net Periodic Pension CostCurrent
      service cost
              $       254
              $       254
              $    69
              $      77Interest
      cost
              649
              640
              49
              48Actual
      return on plan assets
              (148)
              (1,515)
              -
              (1)Actuarial
      (gain) loss
              (1,278)
              (47)
              (119)
              (43)Other
      benefits
              2
              -
              -
              -Costs
      arising in the year
              (521)
              (668)
              (1)
              81Differences
      between costs arising in the year and costs recognized in the year in
      respect of:Return
      on plan assets
              (622)
              774
              -
              -Actuarial
      loss (gain)
              1,285
              65
              103
              26Increase
      (decrease) in valuation allowanceprovided
      against accrued benefit asset
              1
              -
              -
              -Net
      periodic benefit cost of plans
              143
              171
              102
              107Amount
      charged to affiliates
              (6)
              -
              (4)
              -Net
      defined benefit pension and other employee benefits expense
      (a)
              $      137
              $      171
              $    98
              $    107Weighted
      average assumptions used to determine the accrued benefit
    costDiscount
      rate
              5.00%
              5.00%
              5.00
      - 5.50%
              5.00
      - 5.50%Expected
      long-term rate of return on planassets
              7.15%
              7.50%
              n/a
              7.50%Rate
      of compensation increase (b)
              2.50%
              4.00%
 
 (a)
              Includes
      $4 of Pension Benefits related to Jazz (2006 - $10), which was
      consolidated until May 24, 2007.
 
 (b)
              A
      rate of compensation increase of 2% in 2006 and 2% in 2007 was used in
      determining the net benefit pension expense and 4% for the remaining
      years.
 
  44
  Notes to the
      Consolidated
      Financial Statements2007
 
  Other
Benefits — Sensitivity Analysis
  Assumed
health care cost trend rates have a significant effect on the amounts reported
for the health care plans. A 9.25% annual rate of increase in the per capita
cost of covered health care benefits was assumed for 2007 (2006 - 9.75%). The
rate is assumed to decrease gradually to 5% by 2013. A one percentage point
increase in assumed health care trend rates would have increased the service and
interest costs by $1 and the obligation by $16. A one percentage point decrease
in assumed health care trend rates would have decreased the service and interest
costs by $1 and the obligation by $16.
  Pension
Plan Cash Funding Obligations
 
 As at
December 31, 2007 and based on the January 1, 2007 solvency valuation, the table
below provides projections for Air Canada's cash pension plan funding
obligations for 2008. The final funding obligation for 2008 will be determined
based on the January 1, 2008 valuation.
  2008Past
      service domestic registered plans
              $    91Current
      service domestic registered plans
              166Other
      pension arrangements
              86$  343
 
 The
most recent actuarial valuation is as at January 1, 2007 and the effective date
of the next required actuarial valuation is January 1, 2008. For domestic
registered pension plans, the funding requirements are based on the minimum past
service contributions disclosed in the January 1, 2007 actuarial valuations plus
a projection of the current service contributions based upon the January 1, 2007
actuarial valuation used for the purpose. Based on a funding outlook, employer
contributions determined in accordance with regulations are expected to increase
by approximately $90 in 2008.
  On
August 9, 2004, the Government of Canada adopted the Air Canada Pension Plan
Solvency Deficiency Funding Regulations (the "Pension Regulations"). The Pension
Regulations allow Air Canada to fund the solvency deficiencies in its Domestic
Registered Plans as of January 1, 2004 over ten years, rather than the five
years required under the ordinary rules, and to pay down such deficiencies by
way of an agreed schedule of variable annual contributions rather than by way of
equal annual contributions as required under the ordinary rules. The Pension
Regulations came into force upon Air Canada's emergence from CCAA protection on
September 30, 2004, on which date Air Canada issued subordinated secured
promissory Notes in an aggregate amount of approximately $347 in favour of the
pension plan trustee. Such Notes will be reduced as the principal amount of the
solvency deficiencies is paid down, and will only be called on the occurrence of
certain specified events of default. The amount of secured promissory Notes
outstanding as at December 31, 2007 is $89 (2006 - $219). The effect of the
issuance of the subordinated security promissory Notes is included within the
fair value of the obligation for pension benefits as reflected in the
Corporation's balance sheet.  The funding of the notes is included, on
a discounted basis, in all future expected cash flows required to fund the
benefit obligation.
  The
composition of the Domestic Registered Plan assets and the target allocation
consist of the following:
 November
      30, 2007
              November
      30, 2006
              Target
      AllocationEquity
      securities
              58.9%
              59.1%
              59.0%Bonds
      and mortgages
              36.1%
              34.7%
              41.0%Cash
      and temporary investments
              5.0%
              6.2%
              0.0%100.0%
              100.0%
              100.0%
 
 Domestic
Registered Plans
  For the
Domestic Registered Plans, the investments conform to the Statement of
Investment Policy and Objectives of the Air Canada Pension Master Trust Fund.
The investment return objective of the fund is to achieve a total annualized
rate of return that exceeds inflation by at least 3.75% over the long
term.
  
 45
  Notes to the
      Consolidated
      Financial Statements2007
  In
addition to the broad asset allocation, as summarized in the asset allocation
section above, the following policies apply to individual asset
classes:
  §
              Equity
      investments can include convertible securities, and are required to be
      diversified among industries and economic sectors. Foreign equities can
      comprise 37% to 43% of the total market value of the trust. Limitations
      are placed on the overall allocation to any individual security at both
      cost and market value. Derivatives are permitted to the extent they are
      not used for speculative purposes or to create
  leverage.
  §
              Bond
      and Mortgage investments are oriented toward risk averse, long term,
      investment grade securities rated "A" or higher. With the exception of
      Government of Canada securities or a province thereof, in which the plan
      may invest the entire fixed income allocation, these investments are
      required to be diversified among individual securities and sectors. The
      target return is comprised of 40% of the total return of the Scotia
      Capital Universe Bond Index and 60% of the total return of the Scotia
      Capital Long Term Bond Index.
  Similar
investment policies are established for the other pension plans sponsored by Air
Canada.
  Air
Canada's expected long-term rate of return on assets assumption is selected
based on the facts and circumstances that exist as of the measurement date, and
the specific portfolio mix of plan assets. Management reviewed anticipated
future long-term performance of individual asset categories and considered the
asset allocation strategy adopted by Air Canada, including the longer duration
in its bond portfolio in comparison to other pension plans. These factors are
used to determine the average rate of expected return on the funds invested to
provide for the pension plan benefits. While the review considers recent fund
performance and historical returns, the assumption is primarily a long-term,
prospective rate.
  Defined
Contribution Plans
  The
Corporation's management, administrative and certain unionized employees may
participate in defined contribution plans. Contributions range from 3% to 6% for
those employees in Canada and 3% - 7% for those participants in the United
Kingdom.  The Corporation contributes an equal amount. The
Corporation’s expense for defined contribution plans amounted to $4 for the year
ended December 31, 2007 (2006 - $7).
   46
  Notes to the
      Consolidated
      Financial Statements2007
 
 14.
      OTHER LONG-TERM LIABILITIES
  2007
              2006Aeroplan
      miles obligations (a)
              $      29
              $    105Unfavourable
      contract liability on aircraft leases (b)
              54
              77Aircraft
      rent in excess of lease payments (c) (Note 2 (Y))
              54
              121Long-term
      employee liabilities (d)
              47
              54Aeroplan
      investment (e)
              142
              -Workplace
      safety and insurance board liabilities
              45
              45Other
      (f)
              112
              81$    483
              $    483
 
  (a)
              Air
      Canada has a liability related to Aeroplan Miles which were issued by Air
      Canada prior to January 1, 2002. Refer to Note 4 for a description of the
      Special charge for Aeroplan Miles in 2006. As of December 31, 2007 a
      liability for approximately 7 billion Miles, or $84, remains in Air
      Canada, of which $55 is included in current liabilities (total liability
      of 15 billion miles, or $163 at December 31, 2006). The amount of the
      additional liability was determined by valuing the incremental Miles at
      the current fair value.
  (b)
              The
      unfavourable contract liability on aircraft leases represents the net
      present value of lease payments in excess of estimated market rents
      related to lease arrangements that existed on fresh start
      reporting.
  (c)
              Included
      in this balance is nil as at December 31, 2007 (2006 - $59) related to
      Jazz, which was consolidated until May 24,
2007.
  (d)
              The
      following table outlines the changes to labour related provisions which
      are included in long-term employee liabilities for balances that existed
      upon the implementation of fresh start reporting on September 30, 2004
      (current portion included in Accounts payable and accrued
      liabilities):
  2007
              2006Beginning
      of year
              
              $      77
              $    144Interest
      accretion
              
              5
              8Adjustment
      (see below)
              
              -
              (23)Amounts
      disbursed
              
              (38)
              (52)Deconsolidation
      of Jazz
              Note
      5
              (4)
              -End
      of year
              
              40
              77Current
      portion
              
              (6)
              (32)$      34
              $      45
 
 During
2006, as a result of a review of the outstanding provisions related to programs
implemented prior to September 30, 2004, it was determined that a portion of the
provision amounting to $23 would no longer be required and was
adjusted.
  The
following table outlines the changes to labour related provisions which are
included in long-term employee liabilities for balances that have been created
subsequent to the implementation of fresh start reporting on September 30, 2004
(current portion included in Accounts payable and accrued
liabilities):
  2007
              2006Beginning
      of year
              
              $      32
              $      13Special
      charge for labour restructuring2007
      ACTS workforce reduction
              
              15
              -2006
      non-unionized reduction
              
              -
              25Charges
      recorded in wages, salaries, and benefits
              
              14
              7Amounts
      disbursed
              
              (33)
              (13)Disposal
      of liabilities related to ACTS
              Note
      6
              (2)
              -End
      of year
              
              26
              32Current
      portion
              
              (13)
              (23)$      13
              $        9
   47
  Notes to the
      Consolidated
      Financial Statements2007
 The
current portion is included in Accounts payable and accrued
liabilities.
  The
Corporation offers certain severance programs to certain employees from time to
time. The cost of these programs is recorded within operating
expenses.
  During
2007, a charge of $15 was recorded in the ACTS segment for the workforce
reduction announced as a result of the termination of a heavy maintenance
contract at ACTS.  As of October 16, 2007, ACTS Aero is accounted for
as an equity investment (see Note 6).
  During
2006 a workforce reduction plan was announced to reduce non-unionized employee
levels by 20 percent. A special charge of $20 was recorded in the Air Canada
segment and $5 in ACTS in 2006 relating to this program.
  (e)
              This
      represents ACE’s negative investment in Aeroplan Income Fund (Note
      4).
  (f)
              Other
      includes asset retirement obligations of the Corporation.  Under
      the terms of their respective land leases, each Fuel Facility Corporation
      has an obligation to restore the land to vacant condition at the end of
      the lease and to rectify any environmental damage for which it is
      responsible. If it were found that the Fuel Facility Corporations had to
      contribute to any remediation costs, each contracting airline would share
      pro rata, based on system usage, in the costs. For all Fuel Facility
      Corporations in Canada in which Air Canada participates, Air Canada has
      recorded an obligation of $7 ($44 undiscounted) representing the present
      value of the estimated decommissioning and remediation obligations at the
      end of the lease using an 8% discount rate, with lease term expiry dates
      ranging from 2032 to 2039. This estimate is based on numerous assumptions
      including the overall cost of decommissioning and remediation and the
      selection of alternative decommissioning and remediation
      approaches.  The estimated fair value of the obligation is
      nil.
  
  48
  Notes to the
      Consolidated
      Financial Statements2007
  
 15.
      STOCK-BASED COMPENSATION
 
 ACE
Stock Option Plan
  Certain
of the Corporation's employees participate in the ACE stock option plan. Plan
participation is limited to employees holding positions that, in ACE Board's
view (or a committee selected by the Board), have a significant impact on ACE's
long term results. The stock option plan provides that the options will have an
exercise price of not less than 100% of the market price of the underlying
shares at the time of grant. Under the terms of the stock option plan, fifty
percent of all options vest over four years. The remaining options vest upon
performance conditions that are based on net income targets established by the
ACE Board over the same time period. All options expire after seven years. The
terms of ACE's stock option plan specify that upon the retirement of the
employee, options granted to that employee may be exercised as the options vest
within three years of such retirement.
  In
compliance with the terms of the ACE stock option plan, in November 2007, the
Board of ACE resolved to immediately vest all remaining unvested ACE stock
options. This resulted in the immediate expense recognition of all deferred
stock based compensation on outstanding ACE options granted to Air Canada
employees, less amounts previously recognized as compensation
expense.  This expense of $12 is included in the amount below in
2007.  As a result of this immediate vesting of all ACE options
granted, no further stock based compensation expense is expected to be recorded
related to the ACE stock option plan.
 
 The
number of ACE stock options granted to employees, the related compensation
expense recorded (post adoption of EIC-162) and the assumptions used to
determine stock-based compensation expense, using the Black-Scholes option
valuation model were as follows:
 2007
              2006Compensation
      expense ($ millions)
              $    19
              $          7Number
      of stock options granted
              -
              748,926Weighted
      average fair value per option granted ($)
              $       -
              $   10.61Aggregated
      fair value of options granted ($ millions)
              $       -
              $          8Weighted
      average assumptions:Risk-free
      interest rate
              -
              4.02%Expected
      volatility
              -
              35%Dividend
      yield
              -
              0%Expected
      option life (years)
              -
              4.50
 
 The
risk-free interest rate above is based on the average yield on the Government of
Canada marketable bonds for the contractual life of the option in effect at the
time of the grant. Expected volatilities used are based on historical
volatilities from traded stock of ACE and other factors. A zero dividend yield
is used based on the historical dividend yield of ACE. The expected life of the
stock options represent the period of time that options granted are expected to
be outstanding and is derived from the output of an option valuation
model.
  In
2007, the amount credited to share capital for ACE stock options exercised was
$86 (2006 - $16). For ACE stock options exercised, shares from treasury are
issued by the Corporation.
  At
December 31, 2007, a total of 1,682,206 (2006 - 3,597,798) stock options were
outstanding, and represented approximately 1.3% (2006 - 2.9%) of ACE’s fully
diluted equity, which was within the Corporation’s guideline of 5%.
   49
  Notes to the
      Consolidated
      Financial Statements2007
  A
summary of the activity related to the Corporation employees participating in
the ACE stock option plan is as follows:
  2007
              2006Options
      (000)
              Weighted
      Average Exercise Price/Share
              Options
      (000)
              Weighted
      Average Exercise Price/ShareBeginning
      of year
              3,598
              $    25.98
              3,187
              $    24.70Granted
              -
              -
              134
              37.65Exercised
              (27)
              18.70
              (111)
              20.00Forfeited
              
              -
              (79)
              20.00Outstanding
      options, prior to distribution January 10, 2007 (March 3,
      2006)
              3,571
              26.04
              3,131
              25.53Adjustment
      - ACE special distribution (a)
              866
              -
              218
              -Outstanding
      options, after special distribution (a)
              4,437
              20.95
              3,349
              23.87Granted
              -
              -
              615
              33.33Exercised
              (1,037)
              17.42
              (338)
              18.80Forfeited
              (2)
              26.16
              (28)
              21.85Outstanding
      options, prior to distribution March 14, 2007
              3,398
              22.02
              3,598
              25.98Adjustment
      - ACE special distribution (a)
              591
              -
              -
              -Outstanding
      options, after special distribution (a)
              3,989
              18.75
              3,598
              25.98Granted
              -
              -
              -
              -Exercised
              (10)
              18.53
              -
              -Forfeited
              (125)
              25.95
              -
              -Outstanding
      options, prior to distribution May 24, 2007
              3,854
              18.53
              3,598
              25.98Adjustment
      - ACE special distribution (a)
              613
              -
              -
              -Outstanding
      options, after special distribution (a)
              4,467
              15.98
              3,598
              25.98Granted
              -
              -
              -
              -Exercised
              (2,591)
              14.15
              -
              -Forfeited
              (194)
              22.22
              -
              -Outstanding
      options, end of year
              1,682
              $   18.09
              3,598
              $   25.98Options
      exercisable, end of year
              1,682
              $   18.09
              613
              $   24.50
 
 (a)
              In
      accordance with the terms of the ACE stock option plan, each distribution
      of Aeroplan and Jazz units  during 2007 and 2006 (Notes 4 and 5)
      triggered an adjustment to the weighted average exercise price and the
      number of options outstanding. Effective on the applicable dates of the
      distributions, the adjustments were applied to all unexercised ACE stock
      options, whether vested or not, in a consistent manner with the adjustment
      to the conversion rate for the convertible senior notes described in Note
      11.
  The
      total intrinsic value of options exercised under this plan during 2007 was
      $56 (2006 - $7).
  2007
      Outstanding Options
              2007
      Exercisable OptionsRange
      of Exercise Prices
              Expiry
      Dates
              Number
      of Options Outstanding
              Weighted
      Average Remaining Life (Years)
              Weighted
      Average Exercise Price/Share
              Number
      of Exercisable Options
              Weighted
      Average Exercise Price/Share$11.05
              2011
              410,977
              4
              $  11.05
              410,977
              $  11.05$21.13
              2012
              552,259
              5
              21.13
              552,259
              21.13$19.10
      - $20.04
              2013
              718,970
              6
              19.79
              718,970
              19.791,682,206
              
              $  18.09
              1,682,206
              $  18.09
 
  
  50
 
 Notes to the
      Consolidated
      Financial Statements2007
 
  2006
      Outstanding Options
              2006
      Exercisable OptionsRange
      of Exercise Prices
              Expiry
      Dates
              Number
      of Options Outstanding
              Weighted
      Average Remaining Life (Years)
              Weighted
      Average Exercise Price/Share
              Number
      of Exercisable Options
              Weighted
      Average Exercise Price/Share$18.70
              2011
              2,025,074
              5
              $  18.70
              419,130
              $  18.70$31.89
      - $38.91
              2012
              820,936
              6
              36.89
              193,867
              37.05$30.61
      - $36.11
              2013
              751,788
              7
              33.70
              -
              -3,597,798
              
              $  25.98
              612,997
              $  24.50
 
  The
aggregate intrinsic value of the exercisable options outstanding at December 31,
2007 is $17 (2006 - $8) and the weighted average remaining life is 4.7
years.
  Air
Canada Long-Term Incentive Plan
  Certain
of Air Canada’s employees participate in the Air Canada Long-term Incentive Plan
(the “Air Canada LTIP”) administered by the Board of Directors of Air Canada.
The Air Canada LTIP which was established at the time of the Air Canada IPO in
November 2006 provides for the grant of options and performance share units to
senior management and officers of Air Canada.
  The
options to purchase shares granted under the Air Canada LTIP have a maximum term
of 10 years and an exercise price based on the fair market value of the shares
at the time of the grant of the options. Options granted under the Air Canada
LTIP will vest over four years and will incorporate performance vesting
features. The performance vesting conditions are based on operating margin
(operating income over operating revenues) and net income targets established by
the Air Canada Board over the same time period. The terms of the Air Canada LTIP
specify that upon the retirement of the employee, options granted may be
exercised as the rights to exercise accrue within three years from the
retirement date.
  The
number of Air Canada stock options granted to employees, the related
compensation expense recorded and the assumptions used to determine stock-based
compensation expense, using the Black-Scholes option valuation model were as
follows:
 2007
              2006Compensation
      expense ($ millions)
              $            4
              $              3Number
      of stock options granted
              482,870
              1,699,678Weighted
      average fair value per option granted ($)
              $       4.32
              $         5.40Aggregated
      fair value of options granted ($ millions)
              $            2
              $              9Weighted
      average assumptions:Risk-free
      interest rate
              3.94%
      - 4.43%
              4.07%Expected
      volatility
              34%  -
      35%
              35%Dividend
      yield
              0%
              0%Expected
      option life (years)
              4.50
              4.50
 
 A
summary of the activity related to Air Canada employees participating in the Air
Canada Long-term Incentive Plan is as follows:
  2007
              2006Options
      (000)
              Weighted
      Average Exercise Price/Share (b)
              Options
      (000)
              Weighted
      Average Exercise Price/ShareBeginning
      of year
              1,700
              $  21.00
              -
              $          -Granted
              483
              14.74
              1,700
              21.00Exercised
              -
              -
              -
              -Forfeited
              (463)
              21.00
              -
              -Outstanding
      options, end of year
              1,720
              $  19.24
              1,700
              $  21.00Options
      exercisable end of year
              155
              $  21.00
              -
              $          -
    51
 Notes to the
      Consolidated
      Financial Statements2007
  2007
      Outstanding Options
              2007
      Exercisable OptionsRange
      of Exercise Prices
              Expiry
      Dates
              Number
      of Options Outstanding
              Weighted
      Average Remaining Life (Years)
              Weighted
      Average Exercise Price/Share
              Number
      of Exercisable Options
              Weighted
      Average Exercise Price/Share$21.00
              2013
              1,237,222
              6
              $  21.00
              154,653
              $  21.00$11.08
      - $18.60
              2014
              482,870
              7
              14.74
              -
              -1,720,092
              
              $  19.24
              154,653
              $  21.00
 
 2006
      Outstanding Options
              2006
      Exercisable OptionsRange
      of Exercise Prices
              Expiry
      Dates
              Number
      of Options Outstanding
              Weighted
      Average Remaining Life (Years)
              Weighted
      Average Exercise Price/Share
              Number
      of Exercisable Options
              Weighted
      Average Exercise Price/Share$21.00
              2013
              1,699,678
              7
              $  21.00
              -
              $         -
 
 The
Long-term Incentive Plan also includes Performance Share Units (“PSUs”). The
value of the PSUs is based on the fair market value of the shares at the
time of the grant. The vesting term of PSUs is three years, commencing generally
on January 1 of the year following granting, and incorporate performance vesting
features based upon achieving the average Earnings Per Share target established
over the vesting period. Subject to vesting and other conditions, each PSU shall
entitle the employee to receive a payment in the form of one common share, cash
in the amount equal to market value of one common share, or a combination
thereof, at the discretion of the Board of Directors.  The terms of
the plan specify that upon the retirement of an employee, the number of PSUs
that vest will be prorated based on the total number of completed months of
active service during the PSU vesting term.
  The
number of PSUs granted to employees and the related compensation expense were as
follows:
  2007
              2006Compensation
      expense ($millions)
              $           2
              $            -Number
      of PSUs granted
              232,760
              345,805Weighted
      average fair value per PSU granted ($)
              $    16.46
              $    19.40Aggregate
      fair value of PSUs granted
              $           4
              $           7
 
  During
the year 27,314 PSU’s were forfeited (2006 – nil).
  Aeroplan
Long-Term Incentive Plans
  Aeroplan
has an Initial Long-Term Incentive Plan (“Aeroplan Initial LTIP”) that granted
Aeroplan Fund Units to key employees as a one time special award. On March 31,
2006 ACE exchanged on a 1:1 basis 500,000 of its Aeroplan Limited Partnership
units into Aeroplan Income Fund units (“Fund Units”). The Aeroplan Income Fund
units were transferred to a trust for the purpose of funding the Aeroplan
Initial LTIP. The transfer was recorded at the carrying amount of the net assets
transferred and does not give rise to a gain or loss within ACE. Under the terms
of the plan, 50% of the units granted are subject to vesting conditions based on
Aeroplan’s performance and 50% vest based on time. Performance based units vest
at the end of each performance period if distributable cash targets established
by the Aeroplan Board of Directors for each of the periods ended December 31,
2005, 2006 and 2007 are met, or on a cumulative basis at the end of the
following performance period if such targets are met in the following
performance period. Forfeited units that do not meet the vesting conditions and
accumulated distributions thereon accrue back to ACE.
  Aeroplan
has an On-going Long-Term Incentive Plan (“Aeroplan On-going LTIP”) that grants
yearly Aeroplan Fund Units to eligible employees on a basis of a percentage of
their annual base salary Aeroplan also has an Omnibus Plan in order to attract
and/or retain employees, in which vesting is typically time based, with units
vesting 3 years after the grant.
   52
  Notes to the
      Consolidated
      Financial Statements2007
  The
Aeroplan segment recorded compensation expense of $1 for the period to March 14,
2007 and $3 during 2006 for the above plans.
  Jazz
Long-Term Incentive Plan
  Jazz
has a similar Initial Long-Term Incentive Plan (“Jazz Initial LTIP”) that
granted Jazz Fund Units to key employees as a one-time special award. A total of
603,903 Jazz Fund Units were granted. Under the terms of the plan, 50% of the
units granted are subject to vesting conditions based on Jazz’s performance and
50% vest on December 31, 2008. The Jazz segment recorded compensation expense of
$1 for the period ended May 24, 2007 and $2 during 2006 related to this
plan.
  For the
period ended May 24, 2007, the net amount credited to contributed surplus for
the stock-based compensation plans of the Corporation was $1 (2006 -
$19).
  Employee
Ownership Plans
  Employee
ownership plans have been established for shares of ACE, Air Canada, Aeroplan or
Jazz under which eligible employees are allowed to up to 6% of their base salary
for purchase of shares on the secondary market.  The Corporation will
match 33.3% of the investments made by the employee. During 2007, the
Corporation recorded compensation expense of $1 (2006 - $2) in the Air Canada
segment, less than $1 in the Aeroplan segment up to March 14, 2007 ($2006 - $1)
and nil for the Jazz segment up to May 24, 2007 (2006 - $2) for these employee
ownership plans. During 2007, the ACE employee share purchase plan was wound
up.
  
 53
  Notes to the
      Consolidated
      Financial Statements2007
  
 16.
      SHAREHOLDERS’ EQUITY
 
 The
issued and outstanding common shares of ACE, along with potential common shares,
are set out below.  See Note 24 for details of a substantial issuer
bid, which closed on January 10, 2008.
  Outstanding
      shares (000)
              2007
              2006Issued
      and outstandingClass
      A variable voting shares (a)
              82,229
              79,499Class
      B voting shares (a)
              23,709
              22,772Total
      issued and outstanding
              105,938
              102,271Potential
      common sharesConvertible
      preferred shares (b)
              11,291
              10,747Convertible
      notes (c)
              12,210
              7,354Stock
      options
              1,682
              3,598Total
      potential common shares
              25,183
              21,699
 
 The
information presented in the table above reflects the adjustments to the
convertible notes and stock options in connection with the distributions of
units of Aeroplan Income Fund and units of Jazz Air Income Fund.
  Share
      capital and Other equity (net of issue costs):2007
              2006Share
      Capital and Other equityCommon
      shares (a)
              $    1,898
              $    2,188Adjustment
      to shareholders' equity (b)
              (1,655)
              (1,655)Total
      Share Capital
              243
              533Convertible
      preferred shares (c)
              117
              117Convertible
      notes (d)
              90
              92Total
      Share Capital and Other equity
              $       450
              $       742
 
  During
2007 the Corporation, issued 3,665,774 (2006 - 449,109) common shares on the
exercise of stock options for cash consideration of $56 (2006 - $8), $86 (2006 -
$16) including the fair value of exercised stock options transferred to share
capital from surplus. In addition, as a result of the Aeroplan and Jazz
distributions (Notes 4 and 5), $376 (2006 - $59) was recorded as a reduction in
Share capital.
  Share
capital and other equity is comprised of:
  (a)
              Common
      shares
  Class
A Variable Voting Shares
  The
Class A Variable Voting Shares may be held only by persons who are not Canadians
and are entitled to one vote per Class A Variable Voting Share unless (i) the
number of Class A Variable Voting Shares outstanding (including the Convertible
Preferred Shares, on an as-converted basis), as a percentage of the total number
of votes attaching to voting shares outstanding exceeds 25% or (ii) the total
number of votes cast by or on behalf of holders of Class A Variable Voting
Shares (including the Convertible Preferred Shares on an as-converted basis) at
any meeting exceeds 25% of the total number of votes that may be cast at such
meeting. If either of the above noted thresholds would otherwise be surpassed at
any time, the vote attached to each Class A Variable Voting Share will decrease
proportionately such that (i) the Class A Variable Voting Shares as a class
(including the Convertible Preferred Shares on an as-converted basis) do not
carry more than 25% of the aggregate votes attached to all issued and
outstanding voting shares of ACE and (ii) the total number of votes cast by or
on behalf of holders of Class A Variable Voting Shares (including the
Convertible Preferred Shares on an as-converted basis) at any meeting do not
exceed 25% of the votes that may be cast at such meeting.
  
 54
  Notes to the
      Consolidated
      Financial Statements2007
  Class
B Voting Shares
  The
Class B Voting Shares may be held only by persons who are Canadians. Each Class
B Voting Share shall confer the right to one (1) vote in person or by proxy at
all meetings of shareholders of the ACE.
  The
changes during 2007 in the outstanding common shares and their aggregate stated
value were as follows:
 2007Number
      (000)
              AmountIssued,
      beginning of year
              102,271
              $    2,188Shares
      issued on the exercise of stock options
              3,667
              86Special
      distributions
              -
              (376)105,938
              $    1,8982006Number
      (000)
              AmountIssued,
      beginning of year
              101,822
              $    2,231Shares
      issued on the exercise of stock options
              449
              16Special
      distributions
              -
              (59)102,271
              $    2,188
 
 (b)
              Adjustment
      to Shareholders’ Equity
  As a
result of the financial reorganization under CCAA, the assets and liabilities of
the consolidated entity excluding goodwill, were comprehensively valued to fair
values and a revaluation adjustment of $3,395 was recorded as a credit to share
capital.  GAAP does not permit goodwill to be recorded even if the
fair value of net assets is less than the fair value of the enterprise as a
whole.
  (c)
              Convertible
      Preferred Shares
  As at
September 30, 2004, 12,500 Convertible Preferred Shares were issued for
consideration of $250 before fees of $12. These Convertible Preferred Shares are
convertible into 11,291,046 common shares, based on the conversion ratio
applicable as at December 31, 2007.
  For
accounting purposes, the Convertible Preferred Shares are presented as a
compound instrument. At the date of issuance, the value ascribed to the holders’
conversion option, which is presented as equity, was $123 less allocated fees of
$6; the value ascribed to the financial liability was $127. The Convertible
Preferred Shares will increase by 5% per annum, compounded semi-annually from
the date of issuance (“Fully Accreted Value”) resulting in an accretion on the
financial liability at an effective interest rate of 12%. The financial
liability amounted to $182 at December 31, 2007 ($166 at December 31,
2006).
  The
holders of Convertible Preferred Shares are entitled to vote on an as converted
basis with the Variable Voting Shares and the Voting Shares and to the extent
that they are held by persons who are not Canadians they shall be subject to the
same proportionate reduction in voting percentage as if, for voting purposes
only, the Convertible Preferred Shares had been converted into Variable Voting
Shares.
  The
holders of Convertible Preferred Shares shall participate on an as converted
basis with the Variable Voting Shares and the Voting Shares with respect to all
dividends, distributions, and similar transactions The Convertible Preferred
Shares are convertible at the option of the holders thereof at any time into
Variable Voting Shares, if held by a non-Canadian, or into Voting Shares, if
held by a Canadian, at a conversion rate equal to the Fully Accreted Value per
Convertible Preferred Share (as of the conversion date) divided by the
Conversion Price. For the purposes of the terms of the Convertible Preferred
Shares, “Conversion Price” is equal to $26 or 130% of the initial per share
value attributed to the Variable Voting Shares and Voting Shares on September
30, 2004 of $20. The Conversion Price of the Convertible Preferred Shares is
subject to certain adjustments, including customary public company anti-dilution
protection for stock splits, stock dividends, subdivisions, combinations and
similar transactions. split-off,
   55
  Notes to the
      Consolidated
      Financial Statements2007
  subscription
rights or other offers or rights made available to holders of Variable Voting
Shares and Voting Shares and any other similar transactions.
  Mandatory
Conversion
  The
holders of the Convertible Preferred Shares will be required to convert the
Convertible Preferred Shares into fully paid and non-assessable common shares at
the conversion ratio applicable upon the date of conversion, if the closing
price of the ACE shares on the principal market for each of thirty consecutive
trading days exceeded 175% of the conversion price.
  The
Convertible Preferred Shares will also be subject to mandatory conversion into
fully paid and non-assessable common shares within ten days of each mandatory
conversion date, at the conversion ratio applicable upon the date of conversion,
upon the following terms and conditions:
  §
              if
      the closing price of the ACE shares on the principal market exceeds the
      Fully Accreted Value of a preferred share on at least thirty of the one
      hundred trading days immediately prior to a particular mandatory
      conversion date; or
  §
              if
      the closing price of the ACE shares on the principal market does not
      exceed the Fully Accreted Value of a preferred share on at least thirty of
      the one hundred trading days immediately prior to a particular mandatory
      conversion date, (i) the holders of the Convertible Preferred Shares will
      not be required to convert their Convertible Preferred Shares into ACE
      shares and (ii) as of such mandatory conversion date, the then applicable
      conversion price shall be automatically reduced by 3.75%;
    and
  §
              if
      the closing price of the ACE shares on the principal market does not
      exceed the Fully Accreted Value of a preferred share on at least thirty of
      the one hundred trading days immediately prior to the final maturity date,
      then holders of Convertible Preferred Shares will be entitled, upon
      written notice to ACE given within ten days following the final maturity
      date, to require ACE to redeem each of the Convertible Preferred Shares in
      cash at a redemption price equal to the Fully Accreted Value as of the
      final maturity date.
  The
first mandatory conversion date is seven years from the date of
issuance.
  Subject
to the rights, privileges, restrictions and conditions attaching to the shares
of ACE ranking prior to the Convertible Preferred Shares, upon the liquidation,
dissolution or winding-up or distribution of the assets of ACE, the holders of
the Convertible Preferred Shares will be entitled to receive, prior to and in
preference to the holders of ACE shares, an amount equal to the Fully Accreted
Value of the Convertible Preferred Shares as of the date of the liquidation,
dissolution, winding-up or distribution.
  The
holders of Convertible Preferred Shares participate on an as-converted basis
with respect to all dividends, distributions, spin-off, split-off, subscription
rights or other offers made to holders of Class A Variable Voting Shares and
Class B Voting Shares and any other similar transactions.
  (d)
              Convertible
      Notes
  During
2005, the Corporation issued $330 of Convertible Senior Notes due 2035
(“Convertible Notes”) for net proceeds of $319. For accounting purposes, the
Convertible Notes are presented as a compound instrument with the conversion
option reflected in other equity above. Refer to Note 11 for additional
information. In 2007, Convertible Notes with a face value of $6 were converted
at the option of the holder.
  
  56
 
 Notes to the
      Consolidated
      Financial Statements2007
  Accumulated Other
Comprehensive Income
  The
following table outlines the components of Accumulated other comprehensive
income:
  For
      the year ended December 31(Canadian
      dollars in millions)
              
              2007
              2006Accumulated
      Other Comprehensive incomeUnrealized
      period change in fair value of derivatives (net of tax of
    $28)
              
              $    56
              $    -Accumulated
      currency translation adjustment related to ACTS
              
              (2)
              -Total
      comprehensive income
              
              $    54
              $    -
    57
  Notes to the
      Consolidated
      Financial Statements2007
 
 17.
      EARNINGS PER SHARE
 
 The
following table outlines the calculation of basic and diluted earnings per
share:
  (in
      millions, except per share amounts)
              2007
              2006Numerator:Numerator
      for basic earnings per share:Income
      for the year
              $    1,398
              $    408Effect
      of potential dilutive securities:Stock
      options
              -
              -Convertible
      preferred shares
              30
              23Convertible
      notes
              29
              27Adjusted
      numerator for diluted earnings per share
              $    1,457
              $    458Denominator:Denominator
      for basic earnings per share:Weighted-average
      shares
              103
              102Effect
      of potential dilutive securities:Stock
      options
              2
              1Convertible
      preferred shares
              11
              11Convertible
      notes
              11
              7Adjusted
      denominator for diluted earnings per share
              127
              121Basic
      earnings per share
              $    13.51
              $    4.01Diluted
      earnings per share
              $    11.44
              $    3.80The
      calculation of earnings per share is based on whole dollars and not on
      rounded millions.As
      a result, the above amounts may not be recalculated to the per share
      amount disclosed above.
 
  The
dilutive effect of outstanding stock options on earnings per share is based on
the application of the treasury stock method. Under this method, the proceeds
from the exercise of such securities are assumed to be used to purchase Class B
Voting Shares.
  Excluded
from the calculation of diluted earnings per share were outstanding options
where the options’ exercise prices were greater than the average market price of
the common shares for the year, 2007 nil (2006 - 320,886).
   58
  Notes to the
      Consolidated
      Financial Statements2007
 18.
      SEGMENT INFORMATION
 
 Composition of Business
Segments
  During
2007 ACE had the following segments: Air Canada (previously Air Canada
Services), Aeroplan (up to March 14, 2007), Jazz (up to May 24, 2007), ACTS (up
to October 16, 2007) and
Corporate Items and Eliminations (“CIE”).
  CIE
includes the corporate, financing and investing activities of ACE. ACE’s
investments in Aeroplan, Jazz and ACTS Aero were changed in 2007 from the
consolidation to equity method of accounting reported under the CIE
segment.  CIE also includes certain consolidation adjustments related
to revenue recognition differences amongst the operating segments. These
consolidation adjustments are related to the timing of recognition and the
presentation of revenue related to Aeroplan redemptions and the timing of
revenue recognition related to maintenance services provided by ACTS (completed
contract basis of accounting for engine and component maintenance services)
versus the expense recognition in Air Canada and Jazz, which is as the work is
completed. In addition, consolidation adjustments were made related to the
timing of revenue and expense recognition pertaining to power-by-the-hour
contracts. Subsequent to the change in accounting for ACE’s investments in
Aeroplan and ACTS, these consolidation adjustments are no longer recorded in
CIE.  Future income taxes are recorded within the applicable taxable
entities and are not allocated to non-taxable entities.
  The
Aeroplan consolidation adjustments recorded within CIE for the period when
Aeroplan was consolidated related mainly to the revenue recognition timing
difference from when Aeroplan records revenues, which is at the time a Mile is
redeemed for travel, to the consolidated accounting policy of revenue
recognition at the time reward transportation is provided. In addition, within
the Aeroplan segment of the ACE consolidated financial statements, Aeroplan
revenue from the redemption of Miles is recorded in Other revenue, whereas on
the consolidated financial statements, Miles redeemed for travel on Air Canada
and Jazz are recorded in Passenger revenue. This results in an elimination of
certain Aeroplan Other revenue amounts within CIE to reflect the consolidated
recognition of Aeroplan Miles redeemed for travel on Air Canada and Jazz within
Passenger revenue. This also results in an adjustment to passenger revenue
recorded within CIE. In the Aeroplan segment information, the cost to Aeroplan
of purchasing rewards is recorded in other operating expenses.
  The
Jazz segment, included up to May 24, 2007, is operating under the capacity
purchase agreement (“Jazz CPA”) with Air Canada.
  The
ACTS segment, included up to October 16, 2007, at which point ACE sold
substantially all of the assets and liabilities of ACTS to ACTS
Aero.  ACTS Aero conducts the business previously operated by
ACTS.  ACE retained a 23% interest in ACTS Aero.
  Segment
financial information has been prepared consistent with how financial
information is produced internally for the purposes of making operating
decisions. Segments negotiate transactions between each other as if they were
unrelated parties.
   59
  Notes to the
      Consolidated
      Financial Statements2007
  A
reconciliation of the total amounts reported by each business segment to the
applicable amounts in the consolidated financial statements
follows:
 
 2007*
              2006Air
      Canada
              Aeroplan
              Jazz
              ACTS
              CIE
              Total
                ACE
              Air
      Canada
              Aeroplan
              Jazz
              ACTS
              CIE
              Total
                ACEPassenger
      revenue
              $  9,329
              $     -
              $     -
              $    -
              $     15
              $
      9,344
              $
      8,887
              $       -
              $       -
              $        -
              $    82
              $
      8,969Cargo
      revenue
              548
              -
              -
              -
              -
              548
              625
              -
              -
              -
              -
              625Other
      revenue
              649
              198
              3
              193
              (109)
              934
              558
              759
              7
              228
              (489)
              1,063External
      revenue
              10,526
              198
              3
              193
              (94)
              10,826
              10,070
              759
              7
              228
              (407)
              10,657Inter-segment
      revenue
              120
              3
              610
              604
              (1,337)
              -
              196
              10
              1,374
              627
              (2,207)
              -10,646
              201
              613
              797
              (1,431)
              10,826
              10,266
              769
              1,381
              855
              (2,614)
              10,657Special
      charge for Aeroplan miles
              -
              -
              -
              -
              -
              -
              (102)
              -
              -
              -
              -
              (102)Total
      revenues
              10,646
              201
              613
              797
              (1,431)
              10,826
              10,164
              769
              1,381
              855
              (2,614)
              10,555Wages,
      salaries and benefits
              1,920
              17
              139
              272
              35
              2,383
              1,816
              79
              311
              331
              16
              2,553Aircraft
      fuel
              2,552
              -
              125
              -
              (124)
              2,553
              2,544
              -
              285
              1
              (284)
              2,546Aircraft
      rent
              282
              -
              57
              -
              (16)
              323
              341
              -
              134
              -
              (34)
              441Airport
      and navigation fees
              1,022
              -
              80
              -
              (81)
              1,021
              982
              -
              178
              -
              (177)
              983Aircraft
      maintenance, materials and supplies
              757
              -
              50
              235
              (527)
              515
              768
              -
              98
              234
              (629)
              471Communications
      and information technology
              275
              7
              2
              13
              (16)
              281
              273
              24
              8
              14
              (30)
              289Food,
      beverages and supplies
              313
              -
              6
              -
              (1)
              318
              322
              -
              15
              -
              (2)
              335Depreciation,
      amortization and obsolescence
              548
              3
              9
              31
              (9)
              582
              493
              14
              21
              31
              17
              576Commissions
              201
              -
              -
              -
              -
              201
              237
              -
              -
              -
              (1)
              236Capacity
      purchase with Jazz
              923
              -
              -
              -
              (386)
              537
              871
              -
              -
              -
              (871)
              -Special
      charge for labour restructuring
              -
              -
              -
              15
              -
              15
              20
              -
              -
              5
              -
              25Other
      operating expenses
              1,420
              134
              83
              211
              (204)
              1,644
              1,383
              512
              187
              241
              (618)
              1,705Total
      operating expenses
              10,213
              161
              551
              777
              (1,329)
              10,373
              10,050
              629
              1,237
              857
              (2,613)
              10,160Operating
      income (loss)
              433
              40
              62
              20
              (102)
              453
              114
              140
              144
              (2)
              (1)
              395Interest
      income
              92
              3
              2
              -
              29
              126
              82
              20
              6
              1
              11
              120Interest
      expense
              (348)
              (3)
              (3)
              (14)
              (52)
              (420)
              (313)
              (15)
              (8)
              (18)
              (24)
              (378)Interest
      capitalized
              108
              -
              -
              -
              -
              108
              62
              -
              (1)
              -
              -
              61Gain
      (loss) on disposal of assets
              19
              -
              -
              -
              1,347
              1,366
              (6)
              -
              -
              -
              399
              393Gain
      (loss) on financial instruments recorded at fair value
              26
              -
              -
              -
              -
              26
              (18)
              -
              -
              -
              -
              (18)Equity
      Investment Income
              -
              -
              -
              -
              71
              71
              -
              -
              -
              -
              -
              -Other
      non-operating income (expense)
              (19)
              (1)
              1
              (2)
              9
              (12)
              2
              (1)
              (1)
              1
              3
              4Non-controlling
      interest
              (9)
              -
              -
              -
              (148)
              (157)
              (12)
              -
              -
              -
              (60)
              (72)Foreign
      exchange gain (loss)
              317
              -
              -
              (4)
              -
              313
              12
              -
              -
              -
              -
              12Recovery
      of (provision for) income taxes
              (190)
              -
              -
              -
              (286)
              (476)
              3
              -
              -
              -
              (112)
              (109)Segment
      income (loss)
              $     429
              $  39
              $  62
              $    -
              $   868
              $
      1,398
              $   (74)
              $  144
              $  140
              $  (18)
              $  216
              $    408
 *Effective March 14,
2007 the results and financial position of Aeroplan and effective May 24, 2007
the results and financial position of Jazz are not consolidated within ACE (Note
1). Effective October 16, 2007, the results and financial position of ACTS Aero
are not consolidated with ACE (Note 1).  Aeroplan, Jazz, and ACTS Aero
equity investment income is recorded within CIE prospectively from March 14,
2007, May 24, 2007, and October 16, 2007 respectively.
   60
  Notes to the
      Consolidated
      Financial Statements2007
  Included
within Depreciation, amortization and obsolescence is depreciation of property
and equipment for 2007 of $516 (2006 - $467).  This is broken down by
segment as follows; Air Canada $505 (2006 - $437), Aeroplan nil (2006 - nil),
Jazz $9 (2006 - $21), ACTS $6 (2006 - $6), and CIE ($4) (2006 -
$3).
  Geographic
Information
  Passenger
      revenues
              2007
              2006Canada
              $    3,977
              $    3,710US
      Transborder
              1,887
              1,841Atlantic
              1,808
              1,814Pacific
              968
              956Other
              704
              648$    9,344
              $    8,969Cargo
      revenues
              2007
              2006Canada
              $       108
              $       118US
      Transborder
              24
              28Atlantic
              219
              224Pacific
              158
              214Other
              39
              41$       548
              $       625
 
  Passenger
and cargo revenues are based on the actual flown revenue for flights with an
origin and destination in a specific country or region. Atlantic refers to
flights that cross the Atlantic Ocean with origin and destinations principally
in Europe. Pacific refers to flights that cross the Pacific Ocean with origin
and destinations principally in Asia. Other revenues are principally derived
from customers located in Canada.
  Segment
Asset Information
  2007*Air
      Canada
              CIE*
              TotalCash
      and cash equivalents
              
              
              
              $     527
              $
      1,773
              $  2,300Short-term
      investments
              
              
              
              712
              127
              839$  1,239
              $
      1,900
              $  3,139Equity
      investments
              
              
              
              $         -
              $    (56)
              $     (56)Additions
      to capital assets (a)
              
              
              
              $  2,596
              $         -
              $  2,622
              (a)Total
      assets
              
              
              
              $11,838
              $
      1,933
              $13,771*Refer
      to note 24 for the impact of subsequent events on CIE’s cash and cash
      equivalents and short term investments.(a)
      The consolidated total includes additions to capital assets of $10 for
      Jazz and $16 for ACTS, that were segments up toMay
      24, 2007 and October 16, 2007 respectively.2006Air
      Canada
              Aeroplan
              Jazz
              ACTS
              CIE
              TotalCash
      and cash equivalents
              $   1,312
              $    167
              $    135
              $         -
              $       240
              $   1,854Short-term
      investments
              798
              453
              -
              -
              73
              1,324$   2,110
              $    620
              $    135
              $         -
              $       313
              $   3,178Additions
      to capital assets
              $      863
              $      25
              $      25
              $        7
              $           -
              $      920Total
      assets
              $
      11,388
              $    824
              $    483
              $    989
              $    (243)
              $
      13,441Substantially
      all of the Corporation’s property and equipment are related to operations
      in Canada.
 
  The
total assets of CIE is net of the inter-company eliminations between each of the
segments and ACE.
   61
  Notes to the
      Consolidated
      Financial Statements2007
 
 19.
      COMMITMENTS
 
 In
2004, Air Canada signed definitive purchase agreements with Embraer for the
acquisition of regional jet aircraft. In November 2005, Air Canada also
concluded agreements with The Boeing Company ("Boeing") for the acquisition of
Boeing 777 and Boeing 787 aircraft.
  Boeing
  In
November 2005, Air Canada concluded agreements with Boeing for the acquisition
of up to 36 Boeing 777 aircraft and up to 60 Boeing 787 Dreamliners. The initial
order for the 36 Boeing 777 aircraft was comprised of firm orders for 18
aircraft plus purchase rights for 18 more.  The initial order for the
Boeing 787 aircraft was comprised of firm orders for 14 aircraft plus purchase
rights, options and rolling options for 46 aircraft.  In conjunction
with the initial agreements, Air Canada received financing commitments from
Boeing and the engine manufacturer for all firm aircraft orders covering up to
90% of the capital expenditure. This available financing is based on a floating
or fixed rate equivalent and was at 8.70% at December 31, 2007. The term to
maturity is 15 years with principal payments made on a mortgage style basis
resulting in equal instalment payments of principal and interest over the term
to maturity.
 
 During
2007, Air Canada amended agreements with Boeing to cancel orders for two Boeing
777 aircraft scheduled for delivery in 2009. In addition, Air Canada increased
its order for Boeing 787 aircraft by 23, bringing its total firm orders to 37
Boeing 787 aircraft. The first delivery of the Boeing 787 firm aircraft is
scheduled for 2010 and deliveries of all 37 firm aircraft are scheduled to be
completed by 2014. As at December 31, 2007, 18 purchase rights for Boeing 777
aircraft and 23 options for Boeing 787 aircraft remained exercisable. In
January, 2008, Boeing announced a delay in the production of its first Boeing
787 aircraft from the end of the first quarter of 2008 to the end of the second
quarter of 2008 due to production delays.  The Corporation has not
been notified that its Boeing 787 deliveries have been affected, however, Air
Canada expects to receive an update towards the end of the first quarter of
2008
 
 In
conjunction with the amended agreements, Air Canada received additional
financing commitments from Boeing for seven of the additional Boeing 787
aircraft (21 Boeing 787 aircraft in total) on the same terms and conditions as
described above. Should Air Canada not utilize any of the financing commitments
on the Boeing 777 aircraft, the financing commitments for the Boeing 787
aircraft will be increased to 31 aircraft of which the terms for 28 aircraft
would be revised to cover 80% of the aircraft delivery price and the term to
maturity would be reduced to 12 years with straight-line principal repayments
over the term to maturity.
 
 As at
December 31, 2007, seven of the Boeing 777 firm aircraft have been delivered
with the remaining nine firm deliveries expected to be delivered by end of year
2008. The first seven aircraft were financed under loan guarantee support from
EXIM.  All of the nine Boeing 777 firm aircraft deliveries expected in
2008 have commitments for loan guarantee support to be provided by EXIM which
was signed in January, 2008. The loan guarantee, subject to certain conditions,
covers a 12-year loan term for 85 percent of the capital expenditure at an
interest rate based on a floating rate. This loan guarantee from EXIM is
expected to be used instead of the financing commitments provided by Boeing and
the engine manufacturer described above. As a result, it is not expected that
any of Boeing’s and the engine manufacturer’s financing commitments for the
Boeing 777 aircraft will be utilized. The firm commitment financing on capital
purchase commitments disclosed below reflects this guarantee support for only
five aircraft in 2008, given that Air Canada expects to sell and lease back the
other four aircraft (see below).
 
 In
January 2008, Air Canada signed letters of intent for the sale and lease back of
four of the nine Boeing 777 deliveries scheduled for delivery in 2008. The lease
term for two of the Boeing 777 aircraft is 12 years.  The other two
Boeing 777 aircraft each have 10.5 year lease terms and Air Canada has options
to extend each for an additional 18 months.  All four leases are at
market lease rates. This replaces an equivalent number of aircraft loan
guarantee support commitments provided by EXIM. As a result, the capital
expenditure forecast in the table below does not include expenditures relating
to these aircraft. These four aircraft deliveries are included in the operating
lease commitments table below.  The impact of these leases results in
a significant reduction in capital expenditures from what was previously
disclosed. Operating lease commitments have increased as a result of this
change.
 
 
 62
  Notes to the
      Consolidated
      Financial Statements2007
 Embraer
  The
agreement with Embraer covers firm orders for 45 Embraer 190 series aircraft.
The purchase agreement also contains rights to exercise options for up to 60
additional Embraer 190 series aircraft as well as providing for conversion
rights to other Embraer models. As of December 31, 2007, 31 options remain
exercisable.
  The
Embraer 190 series deliveries commenced in December 2005. As at December 31,
2007, 42 of the Embraer 190 series firm aircraft orders have been completed an
additional aircraft was delivered in January 2008.   The two
final Embraer 190 series firm aircraft are scheduled for delivery in the first
quarter of 2008.
 
 Air
Canada has received loan commitments from third parties for the remaining three
firm aircraft covering approximately 80% of the capital expenditure to be repaid
in quarterly instalments for a 12-year term. Two of these aircraft will be based
on floating rates at the 90-day US LIBOR plus 1.90% and one will be based at the
fixed rate equivalent of the 90-day US LIBOR plus 1.70%.
 
 Aircraft
Interior Refurbishment Program
  In
addition to acquiring new aircraft, Air Canada commenced a major refurbishment
of the interior of its existing aircraft in April 2006.  Air Canada
has completed the refurbishment of 26 Airbus A319 aircraft, 30 Airbus A320
aircraft, 10 Airbus A321 aircraft and 15 Boeing 767-300 aircraft to date, for a
total of 81 aircraft. The Embraer and Boeing 777 aircraft are being delivered
with the new seats and entertainment systems already installed. The capital
expenditures associated with this program, which are committed, are amortized
over a five-year period.  A significant portion of the remaining capital expenditures
relating to this program are included in the capital commitments table
below.
  Capital
Commitments
  The
estimated aggregate cost of the future firm deliveries, and other capital
purchase commitments as at December 31, 2007 including the impact of the sale
and lease back transaction described above and the loan guarantee support signed
in January 2008, approximates $4,739 (of which $2,698 is subject to
committed  financing, subject to the fulfillment of certain terms and
conditions). US dollar amounts are converted using the December 31, 2007 noon
day rate of CDN$0.9881. The estimated aggregate cost of aircraft is based on
delivery prices that include estimated escalation and, where applicable,
deferred price delivery payment interest calculated based on the 90-day US LIBOR
rate at December 31, 2007.
  Year
      ending December 31, 2008
              
              
              $       555Year
      ending December 31, 2009
              
              
              102Year
      ending December 31, 2010
              
              
              760Year
      ending December 31, 2011
              
              
              891Year
      ending December 31, 2012
              
              
              692Thereafter
              
              
              1,739$    4,739
 
 Operating
Lease Commitments
  As at
December 31, 2007 the future minimum lease payments under existing operating
leases of aircraft and other property amount to $2,108 (December 31, 2006 -
$2,957) using year end exchange rates.  This also includes payments
for aircraft contemplated by letters of intent signed in January 2008 for the
sale and lease back of four Boeing 777 aircraft as described above.
  
 63
  Notes to the
      Consolidated
      Financial Statements2007
  Operating
      lease commitmentsAircraft
              Other
      Property
              TotalYear
      ending December 31, 2008
              $       280
              $      59
              $       339Year
      ending December 31, 2009
              271
              42
              313Year
      ending December 31, 2010
              255
              36
              291Year
      ending December 31, 2011
              197
              33
              230Year
      ending December 31, 2012
              180
              32
              212Thereafter
              602
              121
              723$    1,785
              $    323
              $    2,108
 
  As
described in Note 22, Air Canada subleases certain aircraft to Jazz on a flow
through basis, which are reported net on the statement of
operations.   These subleases relate to 33 Bombardier CRJ-200 aircraft
and 15 Bombardier CRJ-705 aircraft.  The operating lease commitments under
these aircraft, which are recovered from Jazz, are not included in the aircraft
operating lease commitments table above but are summarized as
follows:
  Year
      ending December 31, 2008
              
              
              $         84Year
      ending December 31, 2009
              
              
              84Year
      ending December 31, 2010
              
              
              76Year
      ending December 31, 2011
              
              
              75Year
      ending December 31, 2012
              
              
              75Thereafter
              
              
              673$    1,067
  The
subleases with Jazz have the same terms and maturity as Air Canada's
corresponding lease commitments to the lessors.
  Lease
payments for aircraft classified as capital leases and variable interest
entities for accounting purposes are disclosed in Note 11.
  As at
December 31, 2007, the future minimum non-cancellable commitments for the next
12 months under the capacity purchase agreements with Jazz is approximately $650
and with unaffiliated regional carriers is $20.  As described in Note
22, the initial term of the Jazz CPA expires December 31, 2015 with two
automatic renewal periods of five years each, subject to either party’s right
not to renew by notice at least one year prior to the expiration of the then
applicable term.  As the rates under the Jazz CPA are subject to
adjustments beginning in 2009, it is not possible to determine the minimum
non-cancellable commitments beyond 2008 however they are not expected to change
significantly from the 2008 amount.
   64
  Notes to the
      Consolidated
      Financial Statements2007
 
 20.
      FINANCIAL INSTRUMENTS AND RISK
MANAGEMENT
 
 Under
its risk management policy, the Corporation manages its currency risk, interest
rate risk, and market risk through the use of various foreign exchange, interest
rate, and fuel derivative financial instruments.  The Corporation uses
derivative financial instruments only for risk management purposes, not for
generating trading profit.
  Interest
Rate Risk Management
  Air
Canada enters into forward interest rate agreements to manage the risks
associated with interest rate movement on US dollar and Canadian dollar floating
rate debt and investments. During 2006 Air Canada entered into 19 interest rate
swaps with a notional value of US$414 to receive floating rates and pay a
weighted average fixed rate of 5.81% for the debt to be arranged in relation to
the financing of Embraer 190 aircraft between June 2006 and February 2008. The
swaps have 15 year terms from the expected delivery date of the aircraft and
their maturities range from June 2021 to December 2022. Air Canada has been
settling the interest rate swaps upon delivery of the related aircraft. Air
Canada did not apply hedge accounting to these derivative instruments. As at
December 31, 2007, one contract remains outstanding with a fair value of $2 in
favour of the counterparty.  (December 31, 2006 - $13 in favour of the
counterparty for 12 contracts outstanding)  During 2007, 11 contracts
settled at a net loss of $10.
  Air
Canada has entered into interest rate swap agreements with a term to January
2024 which convert lease payments related to two B767 aircraft leases
consolidated under AcG-15 from fixed to floating rates.  These have
not been designated as hedges for accounting purposes.  As at December
31, 2007 these two swaps have a fair value of $7 in favour of Air Canada ($4 in
favour of Air Canada as at December 31, 2006).  The notional amount
under these two swaps is $103 (US$104) as at December 31, 2007 (December 31,
2006 - $131 (US$112)).
  Foreign
Exchange Risk Management
  Air
Canada enters into certain foreign exchange forward contracts or currency swaps
to manage the risks associated with foreign currency exchange rates. As at
December 31, 2007, Air Canada had entered into foreign currency forward
contracts and option agreements on $2,132 (US$2,158) and $26 (EUR$18) of future
purchases in 2008 and 2009. The fair value of these foreign currency contracts
as at December 31, 2007 is $124 in favour of third parties (December 31, 2006 -
$25 in favour of Air Canada on $586 (US$503) of future purchases in 2007). These
derivative instruments have not been designated as hedges for accounting
purposes.
  Air
Canada has entered into currency swap agreements for 16 CRJ aircraft operating
leases until lease terminations between 2007 and 2011. During 2007 five currency
swaps were settled with a fair value of $10 (which was equal to carrying value)
(December 31, 2006 - $10 in favour of the counterparties).  Air Canada
has 11 currency swap agreements remaining. These currency swaps with third
parties, have a nominal fair value in favour of Air Canada at December 31, 2007
(December 31, 2006 - $3 in favour of the Air Canada). The notional amount under
these swaps is $78 (US$79) as at December 31, 2007 (December 31, 2006 - $103
(US$88)).  These have not been designated as hedges for hedge
accounting purposes
  Fuel
Price Risk Management
  The
financial results of Air Canada are impacted by changes in jet fuel prices as a
result of Air Canada’s inherent dependence on energy for its operations. To
manage its exposure to jet fuel prices, Air Canada enters into derivative
contracts with financial intermediaries for the purpose of managing volatility
in operating cash flows. Air Canada uses derivative contracts on jet fuel and
also on other crude oil based commodities, such as heating oil and crude oil,
due to the relative limited liquidity of jet fuel derivative instruments on a
medium to longer term horizon, since jet fuel is not traded on an organized
futures exchange. Air Canada does not purchase or hold any derivative financial
instruments for trading purposes.
  As of
December 31, 2007, approximately 20% of Air Canada’s anticipated purchases of
jet fuel for 2008 are hedged. Air Canada's contracts to hedge anticipated jet
fuel purchases over the 2008 period were comprised of jet fuel, heating oil and
crude-oil based contract. Air Canada also hedged approximately 3% of its 2009
anticipated jet fuel purchase in heating oil based contracts and 2% of its 2010
anticipated jet fuel purchase in crude oil based contracts.
   65
  Notes to the
      Consolidated
      Financial Statements2007
  The
following table outlines the notional volumes per barrel along with the weighted
average floor and ceiling price for each year currently hedged.  These
average contract prices represent the equivalent price in West Texas
Intermediate (“WTI”) using the forward prices for WTI, heating oil, and jet oil
as at December 31, 2007:
 Notional
      Volumes (bbl)
              Term
              WTI-equivalent
      Average Floor Price (USD$/bbl)
              WTI-equivalent
      Average Ceiling Price (USD$/bbl)4,890,000
              2008
              $    77.97
              $    81.58840,000
              2009
              $    76.03
              $    80.92480,000
              2010
              $    84.20
              $    88.00
 
  Air
Canada designates certain of its fuel derivatives as cash flow hedges and
applies hedge accounting as prescribed under CICA section 3865, Hedges.
Designated hedging items under cash flow hedges result in all period changes in
the fair value of the hedging item that are considered effective being recorded
in AOCI until the underlying jet fuel is consumed. Upon maturity of the hedging
item, the effective gains and losses are recorded in fuel expense. The
ineffective component of the change in fair value is recorded in Non-operating
income (expense) when it occurs.
  Effectiveness
is defined as the extent to which changes in the fair value of a hedged item
relating to a risk being hedged is offset by changes in the fair value of the
corresponding hedging item. Air Canada’s accounting policy measures
effectiveness based on the change in the intrinsic value of fuel derivatives
compared to the change in the intrinsic value of the anticipated jet fuel
purchase (based on Air Canada’s weighted average price). As Air Canada’s current
policy does not take into account variables affecting fair value such as
volatility and time value of money, a significant component of the change in
fair value of outstanding fuel derivatives may be recorded as ineffective under
the current policy.
  Ineffectiveness
is inherent in hedging diversified jet fuel purchases with derivative positions
in crude oil and related commodities and in the differences between intrinsic
values and fair market values of the derivative instruments, especially given
the magnitude of volatility observed in oil market prices. As a result Air
Canada is unable to predict the amount of ineffectiveness for each period. This
may result, and has resulted, in increased volatility in the accounting results
of Air Canada, but has no impact on the underlying cash flows.
  If the
hedge ceases to qualify for hedge accounting, any period change in fair value of
the fuel derivative instrument is recorded in Non-operating income (expense).
For those fuel derivatives that do not qualify for hedge accounting, the period
changes in fair value of the fuel derivative is recorded in Non-operating income
(expense).
  During
2007, hedge accounting was discontinued for certain fuel hedge contracts where
the hedging relationship ceased to satisfy the conditions for hedge
accounting.   The value of the AOCI balance recognized in
connection with these derivatives will be taken into fuel expense upon the
maturity of the contracts.  Air Canada still continues to hold these
derivatives as it believes they continue to be good economic hedges in managing
its exposure to jet fuel prices.
  The
following information summarizes the financial statement impact of derivatives
designated under fuel hedge accounting, before the impact of tax:
  §
              The
      fair value of outstanding fuel derivatives under hedge accounting at
      December 31, 2007 is $67 in favour of Air
  Canada.
  §
              The
      2007 benefit to Fuel expense for the year ended December 31, 2007 is
      $31.
  §
              The
      Non-operating income (loss) for the year ended  December 31,
      2007 is $12.  The amount in Non-operating income (loss)
      represents the ineffective portion of the fair value change in items under
      hedge accounting.
  §
              The
      effective change in the fair value of derivatives recorded in OCI for the
      period is $110 before tax expense of $28.  OCI amounts for the
      year ended December 31, 2007 are presented net of this tax expense in the
      Consolidated statement of comprehensive
Income.
  
 66
  Notes to the
      Consolidated
      Financial Statements2007
  The
estimated net amount of existing gains and losses reported in AOCI that is
expected to be reclassified to net income during 2008 is $68.
  The
following information summarizes the financial statement impact of derivatives
not designated under fuel hedge accounting, but held as economic hedges, before
the impact of tax:
  §
              The
      fair value of outstanding fuel derivatives not under hedge accounting at
      December 31, 2007 is $10 in favour of the
  Corporation.
 
 §
              The
      Non-operating gain for the year ended December 31, 2007 is
      $26.  The amount in Non-operating income (loss) represents the
      change in fair value of these contracts (realized and unrealized) for the
      current year.
 
 Concentration
of Credit Risk
  The
Corporation does not believe it is subject to any significant concentration of
credit risk. Cash and short-term investments are in place with major financial
institutions, Canadian governments and major corporations. Accounts receivable
are generally the result of sales of tickets to individuals often through the
use of major credit cards, through geographically dispersed travel agents,
corporate outlets, or other airlines, often through the use of major credit
cards.  Refer to Note 10 for a description of ABCP held by Air
Canada.
  Financial
Instrument Fair Values in the Statement of Consolidated Financial
Position
  The
carrying amounts reported in the Consolidated statement of financial position
for short term financial assets and liabilities, which includes cash and
short-term investments, accounts receivable and accounts payable approximate
fair values due to the immediate or short-term maturities of these financial
instruments.   Cash equivalents and short-term investments are
classified as held for trading and therefore are recorded at fair
value.
  The
carrying amounts of foreign currency and interest rate swaps and fuel
derivatives is equal to the fair value, which is based on the amount at which
they could be settled based on estimated current market rates.
  The
following is a comparison of fair value versus carrying value of the
Corporation’s long-term debt and capital lease obligations, as at December 31,
2007, which was estimated using valuation techniques based on current market
rates of interest for similar financial liabilities:
  Carrying
      Value
              Estimated
      Fair ValueConvertible
      Senior Notes
              $     273
              $     273Direct
      Corporation debt
              2,551
              2,611Debt
      consolidated under AcG-15
              896
              933Capital
      lease obligations
              972
              1,127$  4,692
              $  4,944
 
  In
addition, the Corporation has estimated the fair value of the liability element
of the Convertible preferred shares using similar valuation techniques as noted
above and estimates the fair value at approximately $200 versus a carrying value
of $182.
  
 67
  Notes to the
      Consolidated
      Financial Statements2007
  
 21.
      CONTINGENCIES, GUARANTEES AND
INDEMNITIES
 
 Contingencies
  Investigation
by Competition Authorities Relating to Cargo
  The
European Commission, the United States Department of Justice and the Competition
Bureau in Canada, among other competition authorities, are investigating alleged
anti-competitive cargo pricing activities, including the levying of certain fuel
surcharges, of a number of airlines and cargo operators, including Air Canada, a
number of whom, including Air Canada have received a statement of objections
from the European Commission that sets out the European Commission's preliminary
assessment in relation to such matter. Competition authorities have sought or
requested information from Air Canada as part of their investigations. Air
Canada is cooperating with these investigations, which are likely to lead to
proceedings against Air Canada and a number of airlines and other cargo
operators in certain jurisdictions. Air Canada is also named as a defendant in a
number of class action lawsuits that have been filed before the United States
District Court and in Canada in connection with these allegations. Management
has determined it is not possible at this time to predict with any degree of
certainty the outcome of these proceedings, but these proceedings may result in
a material liability to Air Canada.
   Porter
Airlines Inc.
  In
February 2006, Jazz commenced proceedings before the Ontario Superior Court of
Justice against Porter Airlines Inc. (“Porter”) and other defendants
(collectively the “Porter Defendants”) after Jazz became aware that it would be
excluded from operating flights from Toronto City Centre (Island) Airport (the
“TCCA”). On October 26, 2007, the Porter Defendants counter-claimed against Jazz
and Air Canada alleging various violations of competition law, including that
Jazz and Air Canada’s commercial relationship contravenes Canadian competition
laws, and claiming $850 in damages. Concurrently with the Ontario Superior Court
of Justice proceedings, Jazz commenced judicial review proceedings against the
Toronto Port Authority (”TPA”) before the Federal Court of Canada relating to
Jazz’ access to the TCCA. The Porter Defendants were granted intervener and
party status in these proceedings. In January of 2008, Porter filed a defence
and counterclaim against Jazz and Air Canada making allegations and seeking
conclusions similar to those in the Ontario Superior Court counterclaim. Air
Canada views Porter’s counterclaims in both jurisdictions as being without
merit.
 
 Claim
by the Air Canada Pilots Association
  In
October 2006, the Air Canada Pilots Association (“ACPA”) commenced proceedings
before the Ontario Superior Court of Justice against Air Canada, ACE and certain
members of the board of directors of Air Canada alleging that certain past and
future actions are oppressive to it.  A variety of remedies were
sought against the parties including an injunction to impose, among other
things, limits on corporate distributions including those contemplated under the
ACE plan of arrangement which became effective on October 10,
2006.  Following a hearing in December, 2006, Mr. Justice Cumming of
the Ontario Superior Court of Justice dismissed ACPA’s application for an
injunction and granted respondents’ cross motion to dismiss ACPA’s
claim.  ACPA has not appealed the dismissal of the injunction
application but has appealed the order dismissing its claim and the appeal is
scheduled to be heard by the Ontario Court of Appeal in March 2008. Management
is of the view that the ACPA claim is without merit.
 
  Pay
Equity
  The
Canadian Union of Public Employees (“CUPE”), which represents Air Canada’s
flight attendants, has a complaint before the Canadian Human Rights Commission
where it alleges gender-based wage discrimination.  CUPE claims the
predominantly female flight attendant group should be paid the same as the
predominantly male pilot and mechanics groups because their work is of equal
value.  The complaint dates from 1991 but has not been investigated on
the merits because of a legal dispute over whether the three groups work in the
same “establishment” within the meaning of the Canadian Human Rights
Act.  On January 26, 2006, the Supreme Court of Canada ruled that they
do work in the same “establishment” and sent the case back to the Canadian Human
Rights Commission, which may now proceed to assess the merits of CUPE’s
complaint.  On March 16, 2007, the Canadian Human Rights Commission
referred the complaint against the Corporation for investigation.
   68
  Notes to the
      Consolidated
      Financial Statements2007
  Air
Canada considers that any investigation will show that it is complying with the
equal pay provisions of the Canadian Human Rights Act; however, management has
determined it is not possible, at this time, to predict with any degree of
certainty the final outcome of the Commission's investigation.
  Other
Contingencies
  Various
other lawsuits and claims, including claims filed by various labour groups of
Air Canada are pending by and against the Corporation and provisions have been
recorded where appropriate. It is the opinion of management that final
determination of these claims will not have a significant material adverse
effect on the financial position or the results of the Corporation.
  With
respect to 45 aircraft leases of Air Canada, the difference between the amended
rents as a result of the implementation of the Plan of Reorganization,
Compromise and Arrangement (the ”Plan”) under the Companies’ Creditors
Arrangement Act (“CCAA”) on September on September 30, 2004 and amounts due
under the original lease contracts will be forgiven at the expiry date of the
leases if no material defaults have occurred. If a material default occurs, this
difference plus interest will become due and payable by Air Canada and all
future rent will be based on the original contracted rates. Rent expense is
being recorded on the renegotiated lease agreements and any liability would be
recorded only at the time management believes the amount is likely to
occur.
  Guarantees
  Guarantees
in Fuel Facilities Arrangements
  Air
Canada participates in fuel facility arrangements operated through fuel facility
corporations ("Fuel Facility Corporations"), along with other airlines that
contract for fuel services at various major airports in Canada. The Fuel
Facility Corporations operate on a cost recovery basis. The purpose of the Fuel
Facility Corporations is to own and finance the system that distributes the fuel
to the contracting airlines, including leasing the Land Rights under the land
lease. The aggregate debt of the five Fuel Facility Corporations in Canada that
have not been consolidated by the Air Canada under AcG-15 is approximately $119
as at December 31, 2007 (2006 - $108), which is the Air Canada's maximum
exposure to loss without taking into consideration any cost sharing that would
occur amongst the other contracting airlines. Air Canada views this loss
potential as remote. Each contracting airline participating in a Fuel Facility
Corporation shares pro rata, based on system usage, in the guarantee of this
debt.
  Indemnification
Agreements
  Air
Canada enters into real estate leases or operating agreements, which grant a
license to Air Canada to use certain premises, in substantially all cities that
it serves. It is common in such commercial lease transactions for Air Canada as
the lessee to agree to indemnify the lessor and other related third parties for
tort liabilities that arise out of or relate to the Air Canada's use or
occupancy of the leased or licensed premises. Exceptionally, this indemnity
extends to related liabilities arising from the negligence of the indemnified
parties, but usually excludes any liabilities caused by their gross negligence
or willful misconduct. Additionally, Air Canada typically indemnifies such
parties for any environmental liability that arises out of or relates to its use
or occupancy of the leased or licensed premises.
  In
aircraft financing or leasing agreements, Air Canada typically indemnifies the
financing parties, trustees acting on their behalf and other related parties
and/or lessors against liabilities that arise from the manufacture, design,
ownership, financing, use, operation and maintenance of the aircraft and for
tort liability, whether or not these liabilities arise out of or relate to the
negligence of these indemnified parties, except for their gross negligence or
willful misconduct. In addition, in aircraft financing or leasing transactions,
including those structured as leveraged leases, Air Canada typically provides
indemnities in respect of various tax consequences, including in relation to the
leased or financed aircraft, the use, possession, operation, maintenance,
leasing, subleasing, repair, insurance, delivery, import, export of such
aircraft, the lease or finance arrangements entered in connection therewith,
changes of law and certain income, commodity and withholding tax
consequences.
  When
Air Canada, as a customer, enters into technical service agreements with service
providers, primarily service providers who operate an airline as their main
business, Air Canada has from time to time agreed to indemnify the service
provider against liabilities that arise from third party claims, whether or not
these liabilities arise out of or relate to the negligence of the service
provider, but excluding liabilities that arise from the service provider's gross
negligence or willful misconduct.
   69
  Notes to the
      Consolidated
      Financial Statements2007
  Under
its general by-laws, the Corporation has indemnification obligations to its
directors and officers. Pursuant to such obligations, the Corporation
indemnifies these individuals, to the extent permitted by law, against any and
all claims or losses (including amounts paid in settlement of claims) incurred
as a result of their service to the Corporation.
  The
maximum amount payable under the foregoing indemnities cannot be reasonably
estimated. The Corporation expects that it would be covered by insurance for
most tort liabilities and certain related contractual indemnities described
above.
  
 70
  Notes to the
      Consolidated
      Financial Statements2007
  22.
      RELATED PARTY TRANSACTIONS
 
 At
December 31, 2007 ACE has a 75% ownership interest in Air Canada. Air Canada has
various related party transactions with other ACE related entities, including
Aeroplan, Jazz, and ACTS Aero.  ACTS Aero conducts the business
operated by ACTS subsequent to the monetization completed on October 16, 2007
(refer to Note 6).  ACE’s relationships with Aeroplan, Jazz, and ACTS
Aero are described in Notes 3, 4 and 5 respectively.
  Related
party trade balances, as outlined below, mainly arise from the provision of
services, including the allocation of employee related costs, as further
described in Note 13.  Trade balances between the related parties have
trade terms which generally require payment 30 days after receipt of
invoice.
  The
related party balances resulting from the application of the commercial
agreements were as follows:
 2007Accounts
      receivableAeroplan
      (Air Canada)
              
              $      20Aeroplan
      - distribution receivable (ACE)
              
              3Jazz
      (Air Canada)
              
              85Jazz
      - distribution receivable (ACE)
              
              2ACTS
      Aero (Air Canada)
              
              99$    209Accounts
      payable and accrued liabilitiesJazz
      (Air Canada)
              
              $      71ACTS
      Aero (Air Canada)
              
              88$    159
 
 The
related party revenues and expenses with Aeroplan (period from March 14, 2007 to
December 31, 2007), Jazz (period from May 24, 2007 to December 31, 2007) and
ACTS Aero (period from October 16, 2007 to December 31, 2007) are summarized as
follows:
 2007RevenuesRevenues
      from Aeroplan related to Aeroplan rewardsnet
      of purchase of Aeroplan miles
              
              $    137Property
      rental revenues from related parties
              
              11Revenues
      from corporate services and other
              
              24Aircraft
      sublease revenues from Jazz
              
              14Air
      Canada Ground Handling revenues from Jazz
              
              33Maintenance
      revenue from Jazz (ACTS)
              
              21$    240ExpensesMaintenance
      expense for services from ACTS / ACTS Aero
              
              $    107Expense
      from Capacity Purchase Agreement with Jazz
              
              537Pass
      through fuel expense from Jazz
              
              197Pass
      through airport expense from Jazz
              
              120Pass
      through other expense from Jazz
              
              17Other
      expenses
              
              9Recovery
      of wages, salary and benefit expense for employees assigned to related
      parties
              
              (43)$    944
 
 In
addition to the above revenues and expenses with Jazz, Air Canada transfers fuel
inventory and subleases certain aircraft to Jazz on a flow through basis, which
are reported net on the consolidated statement of operations.
   71
  Notes to the
      Consolidated
      Financial Statements2007
 Summary
of significant related party agreements
  The
Relationship between the Corporation and Aeroplan
  ACE
holds a 20.1% ownership interest in Aeroplan Income Fund as at December 31,
2007.  At December 31, 2006 Aeroplan was a subsidiary of ACE in which
ACE held a 75.3% interest.
  The
transactions between Air Canada and Aeroplan described below are recorded at the
exchange amount and are settled by netting amounts payable against amounts
receivable in accordance with the inter-company agreements with any outstanding
balance paid in the subsequent period. Accordingly the amounts have been
presented, as at December 31, 2007 and December 31, 2006, the amounts have been
presented on a net basis as the parties intend to settle on a net
basis.
  Aeroplan Commercial
Participation and Services Agreement (Aeroplan CPSA)
  Air
Canada and Aeroplan are parties to the Aeroplan CPSA dated June 9,
2004.  Pursuant to the Aeroplan CPSA, Air Canada allocates 8% of the
seat capacity to Aeroplan on the flights operated by Air Canada and Jazz and
certain other air carriers under the Air Canada code (collectively, the "AC
Flights") at a fixed redemption cost. In 2007, the rates charged for such seat
capacity were renegotiated in accordance with the Aeroplan CPSA for the period
January 1, 2008 through to December 31, 2010.Aeroplan may also
purchase an unlimited number of available seats based on published fares with a
variable discount depending on the fare product. Any adjustment to this variable
discount is based on an identified set of parameters. The Aeroplan CPSA also
provides that Aeroplan will be charged the lowest fares charged to any other
loyalty program taking into account Aeroplan’s volume purchase of Air Canada’s
seat inventory.   The Aeroplan CPSA expires June 29, 2020 with
four automatic renewals of five year each, unless either party provides notice
of its intention not to renew at least twelve months prior to the expiry of the
applicable term.
 
 Air
Canada is one of Aeroplan’s leading partners and it pays a fee to participate in
the Aeroplan program, which fee is based on the Aeroplan miles awarded to
Aeroplan members who are Air Canada customers traveling on AC Flights. Aeroplan
is required to purchase a minimum number of reward travel seats on AC Flights
annually, 2007 - $171 (2006 - $170), which number is a function of Aeroplan’s
consumption of seats in the three preceding calendar years. Moreover, Air Canada
is required to purchase a minimum number of Aeroplan miles
annually.
 
 The
Aeroplan CPSA also provides that Aeroplan shall, in return for a service fee,
manage Air Canada’s frequent flyer tier membership program for Air Canada Super
EliteTM, EliteTM and PrestigeTM customers, as well as perform certain marketing and
promotion services for Air Canada, including call centre services for the
frequent flyer tier membership program.
 
 Aeroplan Master Services
Agreement (Aeroplan MSA)
  Air
Canada and Aeroplan are parties to the Aeroplan MSA effective January 1,
2005  pursuant to which, Air Canada provides certain services to
Aeroplan in return for a fee based on Air Canada's fully allocated cost of
providing such services to Aeroplan plus a mark-up to reflect overhead and
administrative costs. Pursuant to the Aeroplan MSA, Air Canada provides Aeroplan
with infrastructure support which is mostly administrative in nature, including
information technology, human resources, finance and accounting, and legal
services. Amounts related to the MSA are included in the above table summarizing
related party revenues and expenses under Revenues from corporate services and
other.
  Aeroplan General Services
Agreement (Aeroplan GSA)
  Air
Canada and Aeroplan are parties to the Aeroplan GSA effective January 1, 2005
pursuant to which Air Canada provides Aeroplan with the services of a group of
call centre employees of Air Canada. Aeroplan must reimburse Air Canada for all
costs, including salary and benefits, related to the call centre employees on a
fully allocated basis. With regard to the shortfall in the pension plan
maintained by Air Canada which covers, among others, these call centre
employees, Aeroplan has agreed to pay an amount not to exceed $11 over a six
year period ending in 2013 to compensate Air Canada for call centre employees'
share of the unfunded Air Canada pension liability.   Either
party may, subject to collective agreements of the employees assigned to
Aeroplan, terminate the GSA upon six months notice.
   72
  Notes to the
      Consolidated
      Financial Statements2007
  Trademark License
Agreement
  Pursuant
to a Trademark License Agreement effective May 13, 2005, Air Canada and Aeroplan
have granted each other reciprocal royalty-free, non-exclusive,
non-sublicensable, non-assignable rights to use certain of each other’s
trademarks around the world which incorporate their names or logos, solely in
association with the Aeroplan Program.  No fees were charged or earned
under this agreement for 2007 and 2006.
  The
Relationship between the Corporation and Jazz
  ACE
holds a 20.1% ownership interest in Jazz Air Income Fund as at December 31,
2007.  On January 24, 2008, ACE’s ownership interest in Jazz Air
Income Fund was reduced to 9.5%.  At December 31, 2006 Jazz was a
subsidiary of ACE in which ACE held a 79.7% interest.  Jazz is
consolidated in these consolidated financial statements under AcG-15 up to May
24, 2007.  Jazz is still considered to be a variable interest entity
to Air Canada, however, is no longer the primary beneficiary under AcG-15. The
deconsolidation of Jazz does not impact any of the contractual arrangements
between Air Canada and Jazz.
  In
addition to the agreements summarized below, Air Canada and Jazz are also
parties to a number of lease agreements pursuant to which Jazz leases or
subleases, from Air Canada, certain premises at airports across
Canada.  Refer to Note 19, Commitments for further
details.
  Jazz Capacity Purchase
Agreement (Jazz CPA)
  Air
Canada and Jazz are parties to the Jazz CPA, effective January 1, 2006, pursuant
to which Air Canada purchases substantially all of Jazz’s fleet capacity based
on predetermined rates, in addition to reimbursing Jazz, without mark-up, for
certain pass-through costs as defined in the Jazz CPA which include fuel,
airport and navigation fees.  The fees include both a variable
component that is dependent on Jazz aircraft utilization and a fixed
component.  The initial term of the Jazz CPA expires December 31,
2015.  There are two automatic renewal periods of five years each,
subject to either party’s right not to renew by notice at least one year prior
to the expiration of the then applicable term.  The rates under the
Jazz CPA are subject to periodic adjustment with the next adjustment scheduled
for the start of 2009.  Amounts related to the CPA are included on the
Expense from CPA with Jazz line in the table above.
 
 Jazz Master Services
Agreement (Jazz MSA)
  Air
Canada and Jazz are parties to the Jazz MSA pursuant to which Air Canada
provides certain services to Jazz in return for a fee based on the fair market
value of the services provided by Air Canada to Jazz.  Pursuant to the
Jazz MSA, Air Canada provides Jazz with infrastructure support consisting
principally of administrative services in relation with information technology,
corporate real estate, environmental affairs and legal services.  Jazz
benefits from certain information technology services available to Air Canada
from third parties and from Air Canada’s internal information technology
resources.
  Either
Air Canada or Jazz may elect to terminate any services under the Jazz MSA
(without terminating the whole Jazz MSA) or the entire Jazz MSA upon one year’s
prior written notice.  The Jazz MSA terminates upon the termination of
the Jazz CPA.
  Jazz Trademark License
Agreements
  Air
Canada and Jazz are parties to the Jazz Trademark License Agreement pursuant to
which Air Canada has granted Jazz a royalty-free, non-exclusive,
non-sublicensable, non-assignable right to use certain trademarks owned or
registered by Air Canada around the world including “Jazz” and certain
trademarks which incorporate the Air Canada name, and/or Air Canada’s roundel
design, solely in association with the Jazz business.  The Jazz
Trademark License Agreement can be terminated in the event that the Jazz CPA is
terminated.  However, Air Canada and Jazz have also entered into a
Jazz Special Trademark Agreement which would grant all of Air Canada’s rights to
the Jazz trademark to Jazz (and preclude Air Canada from using the Jazz
trademark or licensing the Jazz trademark to third parties) upon the occurrence
of certain events involving (i) the expiration or termination of the Jazz CPA
if, at such time, Jazz is no longer an affiliate of Air Canada; (ii) the
occurrence of a change of control pursuant to which Jazz ceases to be an
affiliate of Air Canada if, at or prior to such time, the Jazz CPA has expired
or has been terminated; or (iii) the sale or transfer of all or substantially
all of the assets or business of Jazz to a third party that is not an affiliate
of Air Canada if, at or prior to such time, the Jazz CPA has expired or has been
terminated.
   73
  Notes to the
      Consolidated
      Financial Statements2007
  Air
Canada and Jazz are also parties to a number of lease agreements pursuant to
which Jazz leases or subleases, from Air Canada, certain premises at airports
across Canada.
  The
Relationship between the Corporation and ACTS
  ACTS
was a wholly owned subsidiary of ACE providing full-service maintenance, repair
and overhaul services. As described in Note 6, on October 16, 2007 ACE sold
substantially all of the assets and liabilities of ACTS to ACTS
Aero.  ACTS Aero conducts the business previously operated by
ACTS.  As at December 31, 2007 ACE has a 23% interest in ACTS
Aero.
  The
ACTS Maintenance Agreements, the ACTS Master Services Agreement, the ACTS
Trademark License Agreement, the Repair Schemes and Non-Compete Agreement and
the ACTS General Services Agreements, all between Air Canada and ACTS LP and
described below were assigned from ACTS LP to ACTS Aero upon closing of the
monetization of ACTS (Note 6).
  ACTS Maintenance
Agreements
  ACTS
Aero and Air Canada are parties to a general terms and related services
agreements effective October 1, 2006, pursuant to which ACTS Aero provides
technical services to Air Canada including engine and auxiliary power unit
maintenance services, aircraft heavy maintenance services (excluding line and
cabin maintenance services which are provided by Air Canada), component
maintenance services, paint services, training services and ancillary services.
ACTS Aero serves as Air Canada's exclusive repair agency in respect of aircraft
heavy maintenance, engine maintenance, auxiliary power unit maintenance services
as well as for maintenance services relating to certain components. ACTS Aero
serves as Air Canada's non-exclusive repair agency in respect of other services
provided. Except for the services agreement relating to aircraft heavy
maintenance services which expires in October 2011, and the services agreement
relating to paint services which expires in October 2009, each of the agreements
referred to above expires in October 2013.
  ACTS Master Services
Agreement (ACTS MSA)
  ACTS
Aero and Air Canada are parties to an amended and restated master services
agreement (the “ACTS MSA”), effective January 1, 2007, pursuant to which Air
Canada provides ACTS Aero with services including infrastructure support and
services which are mostly administrative in nature, including information
technology, human resources, finance and accounting, and claims services in
return for fees paid by ACTS Aero to Air Canada.  ACTS Aero may elect
to terminate any services under the ACTS MSA or the entire ACTS MSA upon six
months' prior written notice, with the exception of services relating to
information technology which ACTS Aero cannot terminate prior to the expiry of
the ACTS MSA. Air Canada may elect to terminate any services under the ACTS MSA
or the entire ACTS MSA upon 18 months' prior written notice. These amounts are
recorded in the above table summarizing related party revenues and expenses
under Revenues from corporate services and other.
  ACTS Trademark License
Agreement
  ACTS
Aero and Air Canada are parties to a trademark license agreement (the “ACTS
Trademark License Agreement”), effective September 30, 2004, pursuant to which
Air Canada has granted ACTS Aero a royalty-free, non-exclusive, non-assignable
right to use certain Air Canada trademarks which incorporate the Air Canada
name, and Air Canada's roundel design, solely in association with the provision
of heavy maintenance, component maintenance and supply chain business services
in Canada and the United States.  The ACTS Trademark License Agreement
was amended on closing of the sale of ACTS LP to provide for the termination of
the agreement on October 16, 2008.
  ACTS General Services
Agreements
  ACTS
Aero and Air Canada are parties to an amended and restated general services
agreement (the “ACTS GSA”), effective as of June 22, 2007, pursuant to which Air
Canada provides ACTS Aero with the services of a group of unionized employees
for which Air Canada is reimbursed by ACTS Aero for all costs, including salary
and benefits, on a fully allocated basis. The ACTS GSA may be terminated by
either party at any time upon a 30 days' prior written notice.
 
 
 74
  Notes to the
      Consolidated
      Financial Statements2007
 
 Real Estate
Agreements
  As part
of the closing of the monetization of ACTS LP, Air Canada sold a building to
ACTS Aero for proceeds of $28 effective as of October 16, 2007.  In
connection with the sale, Air Canada and ACTS Aero entered into a land sublease
for certain land contiguous with the building and a service contract whereby Air
Canada provides ACTS Aero certain services related to the operation of the
building.
  ACTS
Aero and Air Canada are parties to a master lease agreement, effective as of
October 1, 2006, pursuant to which ACTS Aero leases space from Air Canada at the
Vancouver, Winnipeg, Toronto and Montreal airports.
 
 The non
unionized employees were transferred to ACTS on October 16,
2007.  Post October 16, 2007, the non-unionized employees of ACTS are
not covered under the GSA.
  Cash Management
System
  Air
Canada managed the cash for ACTS up to October 16, 2007. All cash collected from
billings and sources other than Air Canada is recorded by Air Canada on a daily
basis. Any payments to pay obligations related to operating and financing costs
and capital expenditures other than obligations to Air Canada and other ACE
affiliates were made through the Air Canada cash management system.
Inter-company accounts receivable and payable include any excess cash, (cash
proceeds greater than cash expenditures), cash deficiencies (cash expenditures
greater than proceeds) or deferrals of receipts of payments. The consolidated
statement of cash flows reflects the receipt and repayment of excess cash as a
financing activity and the disbursement and repayment of cash deficiencies as
investing activities.
  Pension and Benefits
Agreement
  Air
Canada, ACTS and ACTS Aero entered into a Pension and Benefits Agreement
effective as of October 16, 2007 (“Pension and Benefits Agreement”), relating to
pension and benefits arrangements pertaining to (i) the non-unionized employees
of Air Canada who were previously assigned to the ACTS operation became
employees of ACTS Aero on October 16, 2007 and (ii) unionized employees of Air
Canada who were assigned to ACTS Aero operation pursuant to general services
agreements between Air Canada and ACTS for the assignment of unionized employees
from Air Canada to ACTS (these agreements were assigned to ACTS Aero upon the
closing of the monetization).  New defined benefit and defined
contribution pension plans as well as other employee and retiree benefit
arrangements (including health, life and disability) are being established by
ACTS Aero (the “ACTS Benefit Arrangements”).
 
 Upon
receipt of regulatory approval where required and based upon valuations of the
relevant pension and benefit arrangements of Air Canada (the “Air Canada Benefit
Arrangements”) as at October 16, 2007, the assets and obligations under the Air
Canada Benefit Arrangements pertaining to the transferring non-unionized
employees will be transferred to ACTS Aero or the ACTS Benefit Arrangements, as
applicable.  Amounts with a present value equal to the solvency
deficiency in the defined benefit pension plans as at October 16, 2007 related
to transferring non-unionized employees will be paid by Air Canada through
quarterly payments to ACTS Aero until 2012.  The present value of
these quarterly payments is also referred to as the compensation
amount.  Until such future time as the assets and obligations under
the Air Canada Benefit Arrangements pertaining to non-unionized employees may be
transferred to ACTS Aero, the current service pension cost and the current
service and interest costs for other employee benefits will be expensed by Air
Canada with a full offset recorded as an amount charged to affiliates (ACTS
Aero).
 
 In
addition, the Pension and Benefits Agreement contemplates similar asset and
liability transfer and compensation arrangements in respect of unionized
employees, which arrangements would take effect at such future time as those
unionized employees may be transferred from Air Canada to ACTS
Aero.  However, the solvency deficiencies in respect of transferring
unionized employees for which the future quarterly compensation payments would
be made are determined as at October 16, 2007, subject to certain adjustments,
and the discount rate used to compute the accounting liability for the unionized
employees’ retiree and disability benefits is fixed as at October 16,
2007.  The compensation payments in respect of these solvency
deficiencies and accounting liabilities would be made quarterly during the five
years beginning after the unionized employees are transferred to ACTS Aero, but
only if such a transfer occurs.  Until such future time as the assets
and obligations under the Air Canada Benefit Arrangement pertaining to unionized
employees may be transferred to ACTS Aero, the current service pension cost and
the current
   75
  Notes to the
      Consolidated
      Financial Statements2007
  service
and interest costs for other employee benefits in respect of Air Canada
employees providing services to ACTS Aero are charged to ACTS Aero.
 
 The
Pension and Benefits Agreement also required that Air Canada provide letters of
credit to ACTS Aero on October 16, 2007, to secure the above-described payment
obligations in respect of the solvency deficiencies of the defined benefit
pension plans and accounting liabilities for other retiree and disability
benefit arrangements. The letters of credit total $101, subject to adjustment
once the exact amounts of the relevant solvency deficiencies and accounting
liabilities as at October 16, 2007 are determined by actuarial
valuations.  The face amount of the letter of credit in respect of the
unionized solvency deficiency is also adjusted annually to recognize past
service costs paid by Air Canada to the plan in respect of unionized employees
assigned to ACTS Aero.  The face amount of the letters of credit
decreases as the related quarterly funding payments described above are
made.  ACTS Aero may call the letters of credit in whole or in part,
in the event of a default as defined in the Pension and Benefits
Agreement.  Collateral equal to the amount of the letters of credit
was paid in cash with the asset recorded in Deposits and other
assets.
 
 Non-Compete and Repair
Schemes Transfer Agreement
  ACTS
Aero and Air Canada are parties to a non-compete and repair schemes transfer
agreement, effective as of October 16, 2007 (the “Repair Schemes and Non-Compete
Agreement”).  Generally described, repair schemes are processes and
methods which may be used in the maintenance and repair of aircraft and related
equipment.  The Repair Schemes and Non-Compete Agreement confirmed an
arrangement and provides for the sale from Air Canada to ACTS  Aero
(as successor to ACTS LP) of an undivided joint ownership interest in repair
schemes owned by Air Canada or approved under Air Canada’s airworthiness
engineering organization as well as the sale from ACTS Aero to Air Canada of an
undivided joint ownership interest in the repair schemes owned or developed by
ACTS Aero and applicable to airframe heavy maintenance services provided by ACTS
to Air Canada under the parties’ airframe heavy maintenance services agreement.
However, in September 2004 as part of the implementation of the Corporation’s
plan of arrangement under the Companies’ Creditors Arrangement Act, the
Corporation had already granted ACTS full and exclusive right to these schemes
on a royalty free basis.
  This
Repair Schemes and Non-Compete Agreement also restricts Air Canada’s ability to
own any equity interest in an entity (other than entities in which Air Canada
previously held interests), or to carry on a business activity, related to the
following commercial maintenance, repair and overhaul services in the airline
industry, namely,   airframe heavy maintenance and paint
services, engine and auxiliary power unit (“APU”) overhaul maintenance
services, and component maintenance services. The applicable non-compete
periods are as follows:
  §
              With
      respect to airframe heavy maintenance services and paint services, the
      non-compete period ends one year after the current heavy maintenance
      services agreement is terminated or expires (the current term of the heavy
      maintenance services agreement expires October 1,
  2011);
  §
              With
      respect to engine and APU overhaul maintenance services, the non-compete
      period ends on October 1, 2015; and
  §
              With
      respect to component maintenance services, the non-compete period ends on
      October 1, 2016;
  The
Repair Schemes and Non-Compete Agreement does not restrict Air Canada from
holding interests in any entities in which it held interests at the time of
concluding the agreement nor does it limit Air Canada’s line maintenance
activities which it continues to operate.
  In
consideration for the transfer of the repair schemes, Air Canada received $20
during 2007 (Note 6).
  The
Repair Schemes and Non-Compete Agreement was assigned to ACTS Aero upon closing
of the ACTS Monetization.
  ACTS Trademark License
Agreement
  In
addition to the above transactions, the ACTS Trademark License Agreement
described above was amended on closing of the ACTS Monetization on October 16,
2007 to provide for the termination of the agreement on October 16,
2008.
  
 76
  Notes to the
      Consolidated
      Financial Statements2007
  Non-recurring transactions between
ACE and Air Canada
  Share purchase rights sold
from Air Canada to ACE
  During
2007 Air Canada entered into an aircraft transaction with an unrelated third
party whereby partial consideration was paid to Air Canada in the form of a
right to acquire shares of the unrelated third party.  The transaction
related to the sale by Air Canada of two Airbus A319 aircraft and the sublease
by Air Canada of an additional two Airbus A319 aircraft, all of which was
completed in 2007 with the exception of one of the Airbus A319 aircraft, which
was completed in early 2008.  Air Canada sold the right to acquire
shares received from the unrelated third party to ACE, at fair value, for
proceeds of $1.
 
 Warrants purchased from
ACE
  During
2007 Air Canada purchased certain share warrants held by ACE for consideration
of $4.  These warrants are for the purchase of shares of an unrelated
third party from which Air Canada purchases services.  The equity of
the unrelated third party is not quoted in an active market and therefore fair
value is not reliably measurable.  As such, the financial instrument
is recorded at cost, being the carrying amount in ACE of nil.
 
 Air Canada
Vacations
  During
2007, ACE sold its remaining 49% interest in Air Canada Vacations to Air Canada
for proceeds of $10.  Air Canada Vacations is now 100% owned by Air
Canada and ACE’s indirect interest in Air Canada Vacations was reduced from
87.25% to 75%.   As a result of the sale, ACE recorded a dilution
gain of $3 related to the non-controlling interest in Air Canada in Other
non-operating income (expense).
  
 77
  Notes to the
      Consolidated
      Financial Statements2007
 
 23.
      RECONCILIATION OF CANADIAN GAAP TO UNITED STATES
  GAAP
 
 The
consolidated financial statements of the Corporation have been prepared in
accordance with Canadian generally accepted accounting principles (“Canadian
GAAP”), which differ in certain respects from accounting principles generally
accepted in the United States (“US GAAP”). The following tables and disclosures
represent the principal reconciling items between US GAAP and Canadian GAAP
affecting the statement of operations and retained earnings and the statement of
financial position, as well as additional disclosures required by US GAAP. A
statement of cash flows prepared under US GAAP is not included because the
differences from the statement of cash flows prepared under Canadian GAAP are
not material.
 
 (Canadian
      dollars – millions except per share data)
              2007
              2006Income
      for the period in accordance with Canadian GAAP
              $   
      1,398
              $   
        408Convertible
      securities (2)
              135
              13Derivative
      financial instruments (3)
              118
              (19)Jazz
      dilution gain (4)
              -
              (41)Air
      Canada dilution gain (5)
              -
              (202)Distributions
      (6,7)
              9
              4Stock-based
      compensation (9)
              (6)
              (7)Aircraft
      leases (10)
              (4)
              (3)Amortization
      of intangible assets (11)
              (28)
              (8)Labour
      related provisions (12)
              -
              23Post-employment
      benefits (13)
              17
              48Employee
      future benefits (15)
              1
              -Secondary
      offering of Aeroplan units (6)
              (48)
              -Secondary
      offering of Jazz units (7)
              30
              -Monetization
      of ACTS (8)
              (31)
              -Non-controlling
      interest (17)
              (26)
              -Income
      adjustments for the period before the following
              167
              (192)Income
      tax adjustment net of non-controlling interest
              36
              7Respective
      period income adjustments in accordance with US GAAP
              203
              (185)Income
      for the period in accordance with US GAAP
              $   
      1,601
              $     
       223Total
      comprehensive income for the period in accordance with Canadian
      GAAP
              $   
      1,459
              $   
         408Respective
      period income adjustments in accordance with US GAAP
              203
              (185)Defined
      benefit pension plans: (a) (15)Minimum
      pension liability adjustment
              -
              74Net
      actuarial gain arising during period
              484
              -Amortization
      of net actuarial loss included in net periodic pension
cost
              3
              -Deconsolidation
      and secondary offering of Jazz units (7)
              7
              -Derivative
      financial instruments (a) (3)
              (82)
              -Available-for-sale
      securities (a) (16)
              -
              (89)Total
      comprehensive income for the period in accordance with US
    GAAP
              $      2
      ,074
              $     
        208Earnings
      per share – US GAAP (19)-
      Basic
              $     15.26
              $       2.01-
      Diluted
              $     12.75
              $       1.97
 (a)
              All
      items in Other Comprehensive Income are shown net of
  tax.
   78
  Notes to the
      Consolidated
      Financial Statements2007
  2007
              2006Deferred
      chargesBalance
      under Canadian GAAP
              $       51
              $     116Aircraft
      leases (10)
              (6)
              (3)Convertible
      securities (2,3)
              6
              (3)Deferred
      finance charges (3)
              42
              -Balance
      under US GAAP
              $       93
              $     110GoodwillBalance
      under Canadian GAAP
              $          -
              $          -Goodwill
      (11)
              -
              675Balance
      under US GAAP
              $          -
              $     675Intangible
      assetsBalance
      under Canadian GAAP
              $     647
              $1,643Distributions
      (6)
              -
              4Goodwill
      (11)
              889
              915Balance
      under US GAAP
              $1,536
              $2,562Deposits
      and other assetsBalance
      under Canadian GAAP
              $     527
              $     323Derivative
      financial instruments (3)
              -
              (1)Available-for-sale
      securities (16)
              -
              23Pension
      asset adjustment (15)
              630
              91Deconsolidation
      of Jazz (7)
              (46)
              -Secondary
      offering of Jazz units (7)
              32
              -Deconsolidation
      of ACTS (8)
              41
              -Monetization
      of ACTS (8)
              (31)
              -Balance
      under US GAAP
              $1,153
              $     436Accounts
      payable and accrued liabilitiesBalance
      under Canadian GAAP
              $1,266
              $1,547Convertible
      notes – embedded derivative (2)
              47
              -Derivative
      financial instruments (3)
              -
              29Balance
      under US GAAP
              $1,313
              $1,576Current
      portion of long-term debt and capital leasesBalance
      under Canadian GAAP
              $     686
              $     367Convertible
      securities (2)
              17
              -Balance
      under US GAAP
              $     703
              $     367Long-term
      debt and capital leasesBalance
      under Canadian GAAP
              $4,006
              $3,759Convertible
      securities (2)
              -
              17Deferred
      finance charges (3)
              42
              -Balance
      under US GAAP
              $4,048
              $3,776Convertible
      preferred sharesBalance
      under Canadian GAAP
              $     182
              $     166Reclassification
      of convertible preferred shares (2)
              (182)
              (166)Balance
      under US GAAP
              $          -
              $          -Future
      income taxesBalance
      under Canadian GAAP
              $       50
              $     136Goodwill
      (11)
              112
              88Balance
      under US GAAP
              $     162
              $     224
 
  
 79
  Notes to the
      Consolidated
      Financial Statements2007
  2007
              2006Pension
      and other benefit liabilitiesBalance
      under Canadian GAAP
              $1,824
              $1,876Additional
      minimum pension liability adjustment (15)
              -
              108Pension
      liability adjustment (7,15)
              93
              227Post-employment
      benefits (13)
              (86)
              (69)Employee
      future benefits (15)
              (1)
              -Balance
      under US GAAP
              $1,830
              $2,142Other
      long-term liabilitiesBalance
      under Canadian GAAP
              $     483
              $     483Convertible
      preferred shares – embedded derivative (2)
              81
              178Convertible
      notes – embedded derivative (2)
              -
              60Distributions
      (6)
              39
              -Deconsolidation
      of Aeroplan (6)
              (174)
              -Secondary
      offering of Aeroplan units (6)
              48
              -Balance
      under US GAAP
              $     477
              $     721Non-controlling
      interestBalance
      under Canadian GAAP
              $     757
              $     695Earnings
      allocation to non-controlling interest
              17
              -Additional
      non-controlling interest – Jazz (4, 7)
              -
              41Additional
      non-controlling interest – Air Canada (5)
              202
              202Balance
      under US GAAP
              $     976
              $     938Temporary
      equityBalance
      under Canadian GAAP
              $         
      -
              $          -Reclassification
      of convertible preferred shares (2)
              219
              200Balance
      under US GAAP
              $     219
              $     200
 
  80
  Notes to the
      Consolidated
      Financial Statements2007
 
 2007
              2006Shareholders’
      equityShare
      capital and other equityBalance
      under Canadian GAAP
              $     450
              $     742Reclassification
      of convertible preferred shares and convertible notes (2)
              (207)
              (209)Future
      income tax (6,7)
              (19)
              (6)Goodwill
      recorded at fresh-start (11)
              1,596
              1,596Distributions
      (7)
              (7)
              -Labour
      related provisions (12)
              (23)
              (23)Balance
      of Share capital and other equity under US GAAP
              $1,790
              $2,100Contributed
      surplusBalance
      under Canadian GAAP
              $     504
              $       25Deconsolidation
      of Aeroplan (6)
              (260)
              -Distributions
      (6)
              (33)
              -Stock-based
      compensation (9)
              -
              (6)Redemption
      of convertible notes
              (1)
              -Balance
      of Contributed surplus under US GAAP
              $     210
              $       19Retained
      earningsBalance
      under Canadian GAAP
              $2,209
              $     810Convertible
      securities (2)
              (57)
              (38)Current
      year income adjustments
              203
              (185)Cumulative
      prior year adjustments:Stock-based
      compensation (9)
              6
              13Future
      income tax (11)
              24
              17Goodwill
      (11)
              (94)
              (94)Intangible
      asset amortization (11)
              (11)
              (3)Derivative
      financial instruments (3)
              (30)
              (11)Post-employment
      benefits (13)
              48
              -Aircraft
      leases (10)
              (3)
              -Distributions
      (6)
              4
              -Labour
      related provisions (12)
              23
              -Jazz
      dilution gain (4)
              (41)
              -Air
      Canada dilution gain (5)
              (202)
              -Convertible
      securities (2)
              (45)
              (58)Balance
      of Retained earnings under US GAAP
              $2,034
              $     451Accumulated
      other comprehensive income (loss)Balance
      under Canadian GAAP
              $       54
              $          -Current
      year adjustments to comprehensive income:Defined
      benefit pension plans: (a) (15)Minimum
      pension liability adjustment
              -
              74Net
      actuarial gain arising during period
              484
              -Amortization
      of net actuarial loss included in net periodic pension
cost
              3
              -Deconsolidation
      and secondary offering of Jazz units (7)
              7
              -Derivative
      financial instruments (3)
              (82)
              -Available-for-sale
      securities (16)
              -
              (89)Cumulative
      prior year adjustments to comprehensive income:Minimum
      pension liability adjustment (15)
              (90)
              (164)Pension
      adjustment (15)
              (136)
              (136)Derivative
      financial instruments (3)
              26
              -Available-for-sale
      securities (16)
              -
              108Balance
      of Accumulated other comprehensive income (loss) under US
    GAAP
              $     266
              $(207)Balance
      of Shareholders’ equity under US GAAP
              $4,300
              $2,363
  
 81
  Notes to the
      Consolidated
      Financial Statements2007
 
 1.           Accounting
for uncertainty in income taxes
 
 Under
US GAAP, the Corporation adopted FASB Interpretation No.48 (“FIN 48”), Accounting for Uncertainty in Income
Taxeson January 1, 2007, which clarifies the accounting for uncertainty
in income taxes recognized in an enterprise's financial statements in accordance
with FASB Statement No. 109, Accounting for Income
Taxes.  This interpretation prescribes a recognition threshold
and measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return.  FIN 48 defines the recognition threshold as more likely than
not, meaning greater than 50 percent, to be sustained upon audit by the taxing
authorities based solely on the technical merits of the position.  If
the recognition threshold is met, the tax benefit is measured and recognized as
the largest amount of benefit that is in management’s judgment more likely than
not to be realized.  If the recognition threshold is not met, no
benefit can be recognized in the financial statements.  The provisions
of FIN 48 also provide guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure and
transition.  In
accordance with the transitional provisions of the standard, prior periods are
not restated for the adoption of this new accounting
standard.
 
 The
Corporation’s balance of uncertain tax positions was not materially impacted as
a result of the adoption of FIN 48. There was no cumulative effect adjustment to
the Corporation’s opening retained earnings. However, during the year ended
December 31, 2007, management determined that a net increase of $35 for
income tax reserves was required for tax positions related to prior
years. This increase in
income tax reserves did not result in any current taxes payable.There
was no impact to the consolidated statement of operations for this net increase
as the future income tax assets were offset by valuation allowance.The amount of unrecognized
tax benefits were $44 at January 1, 2007 and $79at December 31,
2007.
 
 A
reconciliation of the beginning and ending amount of unrecognized tax benefits
is as follows:
  Unrecognized
      tax benefits at January 1, 2007
              $   44Gross
      increases for tax positions of prior years
              50Gross
      decreases for tax positions of prior years
              (15)Unrecognized
      tax benefits at December 31, 2007
              $   79
 
  The
unrecognized tax benefits of $79 at December 31, 2007 are for tax positions that
are permanent in nature and, if recognized, would reduce the effective tax rate
if not for the valuation allowance.
 
 The
Corporation recognizes interest expense and penalties related to unrecognized
tax benefits within the provision for income tax expense on the statement of
operations.  No interest expense or penalties related to unrecognized
tax benefits were recorded during 2007.  As at January 1 and December
31, 2007, the total amount of interest and penalties in relation to uncertain
tax positions in the consolidated statement of financial position is
nominal.
 
 The
Corporation files Canadian federal income tax returns and income tax returns in
various provincial jurisdictions.  In general, the tax years 2003
through 2007 remain subject to examination by Canadian tax
authorities.
  Based
on the outcome of these examinations or as a result of the expiration of
statutes of limitation for specific taxing jurisdictions, it is reasonably
possible that unrecognized tax benefits could change within the next twelve
months.  However, the Corporation can not currently estimate the range
of any possible change.
 
 2.           Convertible
securities
 
 Preferred
Shares
 
 Under
Canadian GAAP, as described in Note 16, the convertible preferred shares issued
in 2004 are presented as a compound instrument. At the date of issuance, the
value ascribed to the holder’s conversion option, which is presented in Share
capital and other equity was $123 less allocated fees of $6; the value ascribed
to the financial liability was $127. Under US GAAP, the convertible preferred
shares contain an embedded derivative which has been reported separately as an
Other long-term liability at its fair value of $81 as at December 31, 2007 ($178
as at December 31, 2006). The convertible preferred shares were initially
recorded at $162 which is the proceeds received less direct costs of issuance
and the fair value of the embedded derivative, as of the date of issuance, and
is included in Temporary equity as the conditions of redemption are not solely
within the
   82
  Notes to the
      Consolidated
      Financial Statements2007
  control
of the Corporation. The adjustment to Convertible preferred shares in 2007 and
Deferred charges in 2006 reflects applying the direct costs of issuance,
recorded against the Convertible preferred shares under Canadian GAAP since
January 1, 2007 and in Deferred charges under Canadian GAAP prior to January 1,
2007, against the amount recorded in Temporary equity.
  For the
convertible preferred shares, the changes in the fair value of the embedded
derivative are included in income and the accretion of the temporary equity to
the redemption value over the period to redemption is reflected as a charge to
Retained earnings. The change in the fair value of the embedded derivative
includes the 5% accretion per annum on the convertible preferred
shares.
  The
adjustment reflects the reversal of interest expense under Canadian GAAP of $21
(2006 - $19); the decrease in the fair value of the embedded derivative amounted
to $97 primarily due to the decrease in the ACE share price from $37.63 per
share to $28.29 per share driven primarily by the 2007 distributions of Aeroplan
and Jazz units (2006 - increase of $13); and the amount charged to Retained
earnings under US GAAP of $19 (2006 - $18).
  Convertible
Notes
 
 Under
Canadian GAAP, as described in Note 11, the convertible notes issued in 2005 are
presented as a compound instrument. As the date of issuance, the value ascribed
to the holders’ conversion option, which is presented in Share capital and other
equity, was $94 less allocated fees of $2; the value ascribed to the financial
liability was $236. Under US GAAP the convertible notes were initially recorded
at $260 which is the proceeds received before costs of issuance and the fair
value of the embedded derivative, as of the date of issuance of $70. The direct
costs of issuance of $11 are recorded in deferred charges. The adjustment also
reflects a decrease to the liability related to the fair value of the embedded
derivative amounting to $13 (2006 -$4) and reduction to interest expense of $4
(2006 - $3). The embedded derivative is reported as accounts payable and accrued
liabilities at its fair value of $47 as at December 31, 2007 (reported as Other
long-term liability, $60 as at December 31, 2006).
  The
summary impact of the convertible securities to the reconciliation of Canadian
GAAP to US GAAP is as follows:
  Preferred
      shares
              Convertible
      notes2007
              2006
              2007
              2006Change
      in fair value of the embedded derivative
              $    97
              $  (13)
              $    13
              $    4Credit
      to interest expense
              21
              19
              4
              3Total
              
              $  118
              $      6
              $    17
              $    7
 
  3.           Financial
instruments & hedge accounting
 
 As
described in Note 2, on January 1, 2007, the Corporation adopted CICA accounting
handbook section 3855, Financial Instruments – Recognition
and Measurement, section 3861, Financial Instruments – Disclosure
and Presentation, section 3865, Hedges, section 1530, Comprehensive Income, section
3251, Equity.
  As a
result of the adoption the standards, under Canadian GAAP, for financial
instruments measured at amortized cost, transaction costs or fees, premiums or
discounts earned or incurred are deducted from the proceeds allocated to the
financial liability. Under US GAAP, unamortized transaction costs are recorded
as deferred charges and are amortized as a component of interest expense. The
adjustment under US GAAP is an increase to deferred charges of $42 and an
increase to long-term debt and capital leases of $42.
 
 With
the adoption of the new Canadian GAAP standards for financial instruments and
hedging activities on January 1, 2007 (as described in Note 2), derivative
instruments are recorded on the consolidated statement of financial position at
fair value. Changes in the fair values of derivative instruments are recognized
in non-operating income (expense) with the exception of derivatives designated
in effective cash flow hedges.
  In a
cash flow hedging relationship, the effective portion of the change in the fair
value of the hedging derivative is recognized in OCI while the ineffective
portion is recognized in non-operating income (expense). Upon maturity of the
fuel derivatives, the effective gains and losses previously recognized in
Accumulated OCI (“AOCI”) are recorded in fuel expense.
   83
  Notes to the
      Consolidated
      Financial Statements2007
  When
hedge accounting is discontinued, the amounts previously recognized in AOCI are
reclassified to fuel expense during the periods when the variability in the cash
flows of the hedged item affects net income.
  Although
the adoption of the new Canadian GAAP standards for financial instruments and
hedging activities on January 1, 2007 (as described in Note 2) have largely
harmonized the accounting treatment of derivative financial instruments under
Canadian and US GAAP, US GAAP reported earnings may continue to exhibit
significant volatility in any given period relative to Canadian GAAP because
under Canadian GAAP, the Corporation has designated its fuel derivatives as cash
flow hedges while under US GAAP, the Corporation has elected not to designate
its fuel derivatives as cash flow hedges.
 
 The
adjustment reflects the reclassification of the unrealized period change in fair
value of fuel derivatives under hedge accounting under Canadian GAAP of $88 (net
of tax of $29) and the reclassification of net realized gains on fuel
derivatives to income under Canadian GAAP of $6 (net of tax of $1) from OCI to
earnings. The transitional adjustment to the new Canadian GAAP standards adopted
January 1, 2007 as described in note 2 is reversed under US GAAP. On January 1,
2007, the adjustment under US GAAP is an increase to the fair value of
outstanding fuel derivatives of $18, an increase to accumulated other
comprehensive income of $26 and an decrease to retained earnings of $5 and a
decrease to non-controlling interest of $3.
  Prior
to January 1, 2007, under Canadian GAAP, derivatives under Air Canada’s
fuel-hedging program were designated as hedges for accounting purposes and hedge
accounting was being applied prospectively from October 1, 2005. Under hedge
accounting, hedging derivatives were not recognized on the balance sheet and
gains or losses on fuel hedging contracts were recognized in earnings as a
component of aircraft fuel expense when the underlying jet fuel being hedged was
used. Under US GAAP, all derivatives were recorded on the balance sheet at fair
value. The Corporation elected not to designate any derivatives as hedging
instruments for US GAAP purposes and as such, changes in the fair value of all
derivative financial instruments were recorded in income. The income adjustment
of $19 in the year ended December 31, 2006 reflects the net change in the fair
value of outstanding derivative contracts, which are recorded in accounts
payable under US GAAP in the amount of $29 in favour of third parties and the
write-off of the asset recorded under Canadian GAAP of $1.
  4.           Jazz
dilution gain
 
 As
described in Note 5, under Canadian GAAP, in the year ended December 31, 2006
ACE recorded a dilution gain of $220 ($210 after tax) as a result of the
dilution of its interest in Jazz. Under US GAAP, the dilution gain is reduced by
$41 due to the impact of adjusting the non-controlling interest for the portion
of goodwill assigned to Jazz.
  5.           Air
Canada dilution gain
 
 As
described in Note 3, under Canadian GAAP, in the year ended December 31, 2006
ACE recorded a dilution gain of $25 ($21 after tax), as a result of the dilution
of its interest in Air Canada. Under US GAAP, the dilution gain is decreased by
$202 to a net loss after tax of $181 due to the impact of adjusting the
non-controlling interest for the portion of additional net assets of Air Canada
under US GAAP; which are primarily related to goodwill.
 
 6.           Aeroplan
 
 Refer
to Note 4 for a detailed description of the distribution of Aeroplan units, the
accounting for Aeroplan as an equity investment and the secondary offering of
Aeroplan units.
 
 Distributions of Aeroplan
units to Preferred Shareholders
 
 Canadian
GAAP
 
 Under
Canadian GAAP, the distributions to preferred shareholders of ACE were
considered non-reciprocal transfers to non-owners since the holders of the
Preferred Shares are not considered owners of the Corporation for accounting
purposes. The transfers were measured at fair value at the date of distribution
and resulted in net interest expense being recorded, which is the fair value of
each distribution less the gain recorded. The gain recorded is the fair value of
the distribution in excess of the Corporation’s proportionate carrying value of
its investment.
   84
  Notes to the
      Consolidated
      Financial Statements2007
  The
Aeroplan units distributed to preferred shareholders resulted in net interest
expense of $6 (2006 - $4), a proportionate reduction to intangible assets of $12
(2006 - $4) related to fair value adjustments to Aeroplan intangibles that are
recorded on consolidation as a result of the dilution of interests and a
proportionate reduction of the negative equity investment in Aeroplan of
$6.
 
 US
GAAP
 
 Under
US GAAP, the distributions to preferred shareholders of ACE were considered
non-monetary non-reciprocal transfers to owners since the host instrument is
classified as temporary equity for accounting purposes. Consistent with the
accounting treatment of the distributions for Class A and Class B shareholders,
non-monetary non-reciprocal transfers to owners are recorded at the carrying
amount of the net assets transferred and do not give rise to a gain or
loss.
 
 For the
year ended December 31, 2007, the adjustment under US GAAP is a reduction to net
interest expense of $6 (2006 – $4), an increase to intangible assets of $12
(2006 - $4) (subsequently reclassified to other long-term liabilities due to the
deconsolidation of Aeroplan described below), a net reduction to contributed
surplus of $33 and an increase to other long-term liabilities of
$39.
 
 Refer
to Note 12 for the accounting entries relating to future income taxes on the
Aeroplan units distributed.
 
 For the
year ended December 31, 2007, the adjustment under US GAAP is a reduction of $32
to future income tax expense, an increase of $25 to intangibles and a decrease
of $7 to  share capital and other equity.
 
 For the
year ended December 31, 2006, under Canadian GAAP, a $65 reduction in future
income tax assets was recorded, consisting of a $59 reduction in Share capital
and Intangible assets for the portion related to the distribution to the Class A
and Class B shareholders and $6 future income tax expense and reduction to
Intangible assets for the portion related to the distribution to preferred
shareholders. Under US GAAP, the $65 reduction in future income tax assets
resulted in a $65 reduction of Share capital and Goodwill. The adjustment for US
GAAP was a $65 increase in Intangible assets, a $65 decrease in Goodwill; a $6
decrease in future income tax expense and a $6 decrease in Share
capital.
 
 Accounting for Aeroplan as
an equity investment
 
 As a
result of the distribution of units of Aeroplan Income Fund on March 14, 2007,
ACE’s ownership interest in Aeroplan was reduced to 40.1%. As of the
distribution date, ACE no longer consolidates the results and financial position
of Aeroplan.
  The
deconsolidation adjustment under US GAAP is a reduction to goodwill of $226, a
reduction to intangible assets of $208, a reduction to contributed surplus of
$260 and a reduction to other long-term liabilities of $174.
 
 Secondary offering of
Aeroplan units
 
 On
October 22, 2007 the Corporation completed the secondary offering of 22.0
million trust units of Aeroplan Income Fund at a price of $21.90 per unit, for a
gain on disposal of $539 under Canadian GAAP.
 
 The
adjustment under US GAAP due to the difference in the carrying amount of the net
investment in Aeroplan underUS
GAAP is a decrease to the gain on disposal of assets of $48 and an increase to
Other Long-term liabilities of $48.
 
 7.           Jazz
 
 Refer
to Note 5 for a detailed description of the distribution of Jazz units, the
accounting for Jazz as an equity investment and the secondary offering of Jazz
units.
 
 Distributions of Jazz units
to Preferred Shareholders
 
 Canadian
GAAP
 
 Under
Canadian GAAP, the distributions to preferred shareholders of ACE were
considered non-reciprocal transfers to non-owners since the holders of the
Preferred Shares are not considered owners of the Corporation for accounting
purposes. The transfers were measured at fair value at the date of distribution
and resulted in net
   85
  Notes to the
      Consolidated
      Financial Statements2007
  interest
expense being recorded, which is the fair value of each distribution less the
gain recorded. The gain recorded is the fair value of the distribution in excess
of the Corporation’s proportionate carrying value of its
investment.
 
 The
Jazz units distributed to preferred shareholders resulted in net interest
expense of $3 and an increase to non-controlling interest of $3 as a result of
the dilution of interests.
 
 US
GAAP
 
 Under
US GAAP, the distributions to preferred shareholders of ACE were considered
non-monetary non-reciprocal transfers to owners since the host instrument is
classified as temporary equity for accounting purposes. Consistent with the
accounting treatment of the distributions for Class A and Class B shareholders,
non-monetary non-reciprocal transfers to owners are recorded at the carrying
amount of the net assets transferred and do not give rise to a gain or
loss.
 
 For the
year ended December 31, 2007, the adjustment under US GAAP is a reduction to net
interest expense of $3 and a reduction to share capital and other equity of
$3.
 
 Refer
to Note 12 for the accounting entries relating to future income taxes on the
Jazz units distributed.
 
 For the
year ended December 31, 2007, the adjustment under US GAAP is a reduction of $5
to future income tax expense and share capital and other equity.
 
 Accounting for Jazz as an
equity investment
 
 As a
result of the distribution of units of Jazz Air Income Fund on May 24, 2007,
ACE’s ownership interest in Jazz was reduced to 49.0%. As of the distribution
date, ACE no longer consolidates the results and financial position of
Jazz.
  The
deconsolidation adjustment under US GAAP is a reduction to non-controlling
interest of $41, a reduction to pension and other benefit liabilities of $9, a
reduction to intangible assets of $4 and a reduction to deposits and other
assets of $46, an increase to OCI of $5 and a reduction to share capital and
other equity of $5.
 
 Secondary offering of Jazz
units
 
 On
October 22, 2007 the Corporation completed the secondary offering of 35.5
million trust units of Jazz Air Income Fund at a price of $7.75 per unit, for a
gain on disposal of $233 under Canadian GAAP.
 
 The
adjustment under US GAAP due in part to the difference in the carrying amount of
the net investment in Jazz underUS
GAAP is an increase to the gain on disposal of assets of $30, an increase to
Deposits and other assets of $32 and an increase to OCI of $2.
 
 8.           ACTS
 
 Refer
to Note 6 for a detailed description of the monetization of ACTS.
 
 Monetization
 
 On
October 16, 2007, ACE sold substantially all the assets and liabilities of ACTS
LP to ACTS Aero in which ACE holds a 23% equity interest. Under Canadian GAAP,
ACE realized a gain of $565 on the monetization. Under US GAAP, the carrying
value of ACE’s investment prior to the sale was $41 higher due to the benefit of
future income tax assets that exist at fresh start recognized to reduce
intangible assets under Canadian GAAP as opposed to goodwill under US
GAAP.  As a result the of the higher investment cost, the gain was
reduced by $31 under US GAAP, calculated as the proportionate carrying amount of
the 77% investment disposition.
 
 9.           Stock-based
compensation
 
 Under
Canadian GAAP, as described in Note 2, the Corporation has adopted EIC-162 in
the period ended June 30, 2006 with restatement of prior periods. EIC-162
requires that the compensation cost for a stock option award attributable to an
employee who is eligible to retire at the grant date be recognized on the grant
date or for an employee who will become eligible to retire during the vesting
period be recognized over the period from
   86
  Notes to the
      Consolidated
      Financial Statements2007
  the
grant date to the date the employee becomes eligible to retire (the
“non-substantive vesting period approach”).
 
 Under
US GAAP, the Corporation adopted Statement of Financial Accounting Standards
(“FAS”) No. 123 (revised 2004), “Share-Based Payment” (“FAS 123R”) on January 1,
2006, which has the same requirements as EIC-162 under Canadian GAAP except FAS
123R is to be applied prospectively from January 1, 2006 to new option awards
that have retirement eligibility provisions. The nominal vesting period approach
is continued for any option awards granted prior to adopting FAS 123R and for
the remaining portion of unvested outstanding options. Under US GAAP, the
adjustment reflects the reversal of the charge to retained earnings of $6 as at
January 1, 2007 ($13 as at January 1, 2006), an increase to Salaries, wages and
benefits expense of $6 for the year ended December 31, 2007 and an increase to
Salaries, wage and benefits expense of $7 for the year ended December 31, 2006,
all with an offset to contributed surplus.
 
 As
disclosed in Note 15, in compliance with the terms of the ACE stock option plan,
effective November 12, 2007, the Board of ACE resolved to immediately vest all
of the remaining unvested ACE stock options.  This resulted in the
immediate expense recognition of all deferred stock based compensation on
outstanding ACE options granted, less amounts previously recognized as
compensation expense. As a result of this immediate vesting of all ACE options
granted, no further stock based compensation expense is expected to be recorded
related to the ACE stock option plan.
 
 10.           Aircraft
leases
 
 Under
Canadian GAAP, when a lease is extended and the payment terms are modified, the
lessee should continue to account for the lease in accordance with the terms of
the original lease contract until the original lease term expires. The
difference between the modified payment and the payment under the terms of the
original lease is deferred. Under US GAAP, any straight-line rent accruals and
other deferred amounts should be amortized over the combined period of the
remaining original lease term and the new lease term. Under US GAAP, additional
aircraft lease expense of $4 has been recorded with the offset to deferred
charges for the year ended December 31, 2007 (2006 -$3).
 
 11.           Fresh
start reporting and goodwill
 
 Under
Canadian GAAP, upon emergence from creditor protection, the identifiable assets
and liabilities of an enterprise are revalued based on the fair values of such
assets and liabilities in a manner similar to that used for a business
combination. The difference between the fair value of the Corporations’ equity
over the fair value of the identifiable assets and liabilities is not permitted
to be recorded as an asset (goodwill) under Canadian GAAP. US GAAP does not
prohibit the recognition of goodwill to the extent that the reorganization value
exceeds the fair value of the specific tangible and identifiable intangibles of
the Corporation. The resulting goodwill under US GAAP is not amortized and is
subject to an impairment test on an annual basis or earlier if an event occurs
or circumstances change that would more likely than not reduce the fair value of
the respective reporting unit below the carrying amount.
 
 Under
Canadian GAAP, the benefit of future income tax assets that exist at fresh
start, and for which a valuation allowance is recorded against, will be
recognized first to reduce to nil any remaining intangible assets (on a pro-rata
basis) that were recorded upon fresh start reporting with any remaining amount
as a credit to shareholders’ equity. Under US GAAP the benefit of future income
tax assets that exist at fresh start will be recognized first to reduce to nil
any goodwill, then intangibles with any remaining amount taken to
income.
 
 The
adjustment in 2007 includes:
 
 §
              a
      cumulative increase to intangibles $1,090 (2006 - $926), less accumulated
      amortization of $39 (2006 - $11);
 §
              a
      cumulative increase to intangibles of $71 (2006 - nil) due to the benefit
      of future income tax assets that exist at fresh start recognized against
      intangibles;
 §
              a
      cumulative increase to future income tax liabilities of $112 (2006 -
      $88);
 §
              a
      cumulative reduction to goodwill of $1,596 which includes a $226 reduction
      of the Goodwill balance described in Item 6 (2006 - $921 cumulative
      reduction, including a $21 reduction of the Goodwill balance described in
      Item 13);
 §
              a
      decrease to future income tax expense of $20 (2006 – increase of
      $1);
 §
              an
      increase (decrease) to tax expense recorded in Other comprehensive Income
      of $284 (2006 - $45);
 §
              an
      increase to Share capital and other equity of $25
  and
 §
              a
      cumulative retained earnings adjustment of $(31) (2006 -
      $(77)).
     87
  Notes to the
      Consolidated
      Financial Statements2007
 
 12.           Labour
related provisions
 
 As
described in Note 14, under Canadian GAAP, in the year ended December 31, 2006 a
review of outstanding labour provisions implemented prior to September 30, 2004
resulted in a $23 reversal of the provision applied against Share capital. Under
US GAAP, the reversal of the $23 labour related provision implemented prior to
September 30, 2004 is applied to income in the current year.
 
 13.           Post-employment
benefits
 
 Under
Canadian GAAP, the actuarial gains and losses related to post-employment
benefits, which are non-accumulating, are amortized over the average expected
period that the benefits will be paid. Under US GAAP, the actuarial gains and
losses related to post-employment benefits, which are non-accumulating, are
included in income in the period that they arise. Under US GAAP, actuarial gains
of $17 (2006 - $48) are recognized during the year ended December 31, 2007, with
a decrease of $17 (2006 – $69) to Pension and other benefit liabilities and a
decrease of nil (2006 - $21) to Goodwill. During the course of preparing the
2006 consolidated financial statements, it was noted that this GAAP difference
had not previously been recorded. As a result, this adjustment recognized during
the year ended December 31, 2006 includes actuarial gains of $21 from the period
prior to October 1, 2004 that were adjusted to Goodwill and actuarial gains of
$39 for the period ended December 31, 2004 and year ended December 31, 2005 that
were recognized in income.
 
 14.           Comprehensive
income
 
 OCI
represents changes in Shareholders’ equity during a period arising from
transactions and other events with non-owner sources that are recognized in
Comprehensive income, but excluded from net income. Period changes in the fair
value of the effective portion of cash flow hedging instruments are recorded in
OCI. Commencing in Quarter 1 2007, interim consolidated financial statements
include the consolidated statement of comprehensive income; items affecting OCI
are recorded prospectively commencing from January 1, 2007, including the
transition adjustments. Cumulative changes in OCI are included in AOCI, which is
presented as a new category within Shareholders’ equity on the consolidated
statement of financial position. OCI and AOCI are presented net of
tax.
 
 The
adoption of the new Canadian GAAP standards for financial instruments and
hedging activities on January 1, 2007 (as described in Note 2) have largely
harmonized the accounting treatment of comprehensive income under Canadian and
US GAAP.
 
 Prior
to January 1, 2007, under US GAAP, comprehensive income was required to be
reported while under Canadian GAAP, the Corporation was not permitted to use the
concept of comprehensive income. Other comprehensive income (loss) for the year
ended December 31, 2006 was $30 less tax of $45, which was net of a valuation
allowance. The adjustments to cumulative other comprehensive income related
mainly to the minimum pension liability adjustment described under Item 15 and
unrealized gains/losses on available for sale securities described under Item
16.
 
 15.           Employee
future benefits
 
 Prior
to the issuance of the new accounting standard for defined benefit plans as
noted below, US GAAP required the unfunded accumulated benefit obligation to be
recorded as additional minimum liability for the year ended December 31, 2006.
The excess of the unfunded accumulated benefit obligation over the unrecognized
prior service costs is recorded in other comprehensive income. The adjustment
results in a $138 increase less tax of $64 to other comprehensive income for the
change in the additional minimum pension liability from $246 at December 31,
2005 to $108 at December 31, 2006.
 
 Accumulated benefit
obligation
 
 Under
US GAAP, the accumulated benefit obligation for the defined benefit pension
plans as at December 31, 2007 was $11,607 (2006 - $12,629).
 
 Funded
status
 
 In
September 2006, the Financial Accounting Standards Board (FASB) issued FASB
Statement 158, “Employers’ Accounting for Defined Benefit Pension and Other
Postretirement Plans, an amendment of FASB
   88
  Notes to the
      Consolidated
      Financial Statements2007
  Statements
No. 87, 88, 106, and 132 (R)” (“FAS 158”). FAS 158 requires an employer to (i)
recognize the overfunded or underfunded status of a defined benefit plan (other
than a multiemployer plan) as an asset or liability with changes in that funded
status recognized through comprehensive income; and (ii) measure the funded
status of a plan as of the year-end date. FAS 158 also specifies additional
disclosure requirements. The US GAAP requirement to initially recognize the
funded status of a defined benefit plan and to provide the required disclosures
was effective as of the end of the fiscal year ending after December 15, 2006.
The US GAAP requirement to measure plan assets and benefit obligations as of the
date of the employer’s fiscal year-end statement of financial position is
effective for fiscal years ending after December 15, 2008. FAS 158 required
prospective application with the transition asset or liability to be recognized
in accumulated other comprehensive income in shareholders’ equity.
  Under
Canadian GAAP, the over or under funded status of defined benefit plans are not
recognized in the statement of financial position. Under Canadian GAAP, the
overfunded or underfunded status of a plan is included in the notes to the
financial statements in the form of a reconciliation of the overfunded or
underfunded status to amounts recognized in an employer’s statement of financial
position.
  The
impact of the adoption of the statement on December 31, 2006 resulted in the
recognition of an additional liability for the unfunded obligation of $200 for
pension plans and $27 for other postretirement plans and a pension asset for the
overfunded obligations of $86 for pension plans and $5 for other postretirement
plans. The offset of these adjustments resulted in a decrease to accumulated
other comprehensive income of $136. The impact of adopting the statement did not
affect reported US GAAP net income.
 
 For the
year ended December 31, 2007, the adjustment under US GAAP is an increase to
other comprehensive income of $432 (net of tax of $253) (comprised of a net
actuarial gain arising during the period of $429 and a credit of $3 resulting
from amortization of net actuarial loss included in net periodic pension cost)
for pension plans and $55 (net of tax of $32) (comprised of a net actuarial gain
arising during the period of $55) for other postretirement plans, an increase to
other assets of $539 and a reduction to pension and other benefit liabilities of
$242. The tax amounts reported above exclude future income tax assets of $58
which are offset by a valuation allowance.
 
 Due to
the deconsolidation of Jazz (refer to item 7 on the accounting for Jazz as an
equity investment), pension and other benefit liabilities of $9 was reclassified
to deposits and other assets.
 
 Net
actuarial gains of nil included in accumulated other comprehensive loss at
December 31, 2007 are expected to be recognized as a component of net periodic
benefit cost during the 2008 fiscal year.
 
 Expected benefit
payments
 
 As at
December 31, 2007, the expected benefit payments for Air Canada defined benefit
plans for the next five years are as follows:
 Pension
      Benefits
              Other
      Benefits2008
              
              
              $    
      660
              $     702009
              
              
              673
              752010
              
              
              687
              802011
              
              
              700
              852012
              
              
              714
              89Total
              
              
              
              $    3,434
              $    399
 
 
 
 89
 
  
 Net periodic benefit
cost
 
 The
components of US GAAP net periodic cost of defined benefit plans include the
following:
 
 Pension
      Benefits
              Other
      Benefits2007
              2006
              2007
              2006Service
      cost
              $   253
              $ 254
              $    69
              $ 77Interest
      cost
              649
              640
              49
              48Expected
      return on plan assets
              (769)
              (741)
              -
              (1)Amortization
      of prior service (credit)/cost
              -
              -
              -
              -Amortization
      of net transition (asset)/obligation
              -
              -
              -
              -Amortization
      or recognition of experience (gains) losses
              7
              18
              (33)
              (65)Amount
      of settlement (gain)/loss recognized
              -
              -
              -
              -Other
      benefits
              2
              -
              -
              -Total
              
              $   142
              $   171
              $    85
              $
        59
 
 (a)
              Under
      Canadian GAAP, the actuarial gains and losses related to post-employment
      benefits, which are non-accumulating, are amortized over the average
      expected period that the benefits will be paid. Under US GAAP, the
      actuarial gains and losses related to post-employment benefits, which are
      non-accumulating, are included in income in the period that they arise.
      During the course of preparing the 2006 consolidated financial statements,
      it was noted that this GAAP difference had not previously been recorded.
      As a result, the ($65) amortization or recognition of experience (gains)
      losses amount presented in 2006 includes an adjustment of $48 related to
      2006 and prior years. Refer to item 13 for a detailed description of the
      adjustment.
 
 Limit on carrying value of
accrued benefit asset
 
 Under
Canadian GAAP, when a defined benefit plan gives rise to an accrued benefit
asset, an entity should recognize a valuation allowance for any excess of the
adjusted benefit asset over the expected future benefit. The accrued benefit
asset should be presented on the entity's balance sheet net of the valuation
allowance. A change in the valuation allowance should be recognized in income
for the period in which the change occurs. Under US GAAP, the recognition of a
valuation allowance is not permitted. Included in the adjustment is the reversal
of the valuation allowance recognized under Canadian GAAP of $1 (2006 –
nil).
 
 16.           Available-for-sale
securities
 
 Financial
assets classified as available-for-sale are measured at fair value with
unrealized gains and losses, including changes in foreign exchange rates, being
recognized in Other Comprehensive Income (“OCI”).
 
 The
adoption of the new Canadian GAAP standards for financial instruments and
hedging activities on January 1, 2007 (as described in Note 2) have largely
harmonized the accounting treatment of available-for-sale securities under
Canadian and US GAAP.
 
 The
transitional adjustment to the new Canadian GAAP standards adopted January 1,
2007 is reversed under US GAAP. On January 1, 2007, the adjustment under US GAAP
is a decrease to deposits and other assets of $19 and a decrease to accumulated
other comprehensive income of $19.
  Prior
to January 1, 2007, under Canadian GAAP, portfolio investments were accounted
for using the cost method. Under US GAAP, portfolio investments classified as
available-for-sale securities are carried at market value with unrealized gains
or losses reflected in comprehensive income. Under US GAAP, an unrealized gain
of $38 less tax of $6 for the year ended December 31, 2006 was recorded as a
separate component of shareholders’ equity and included in other comprehensive
income, to reflect the fair value of the US Airways investments held during the
year. The fair value of the remaining US Airways investment as at December 31,
2006 was $31. This adjustment is in addition to a decrease in other
comprehensive income of $145 less tax of $24 for the year ended December 31,
2006 to reverse the unrealized gains previously recorded in other comprehensive
income, as the gain for the disposal of 4.5 million shares during 2006 was
realized under Canadian GAAP.
   90
  Notes to the
      Consolidated
      Financial Statements2007
 17.           Non-controlling
interest
 
 The
non-controlling interest adjustment of $26 reflects the deduction made in the
amount of the 25% non-controlling interest's proportion of Air Canada's income
or loss adjustments as ACE holds a 75% direct ownership interest in Air
Canada.
 
 18.           Provision
for loss on assets
 
 Under
Canadian GAAP, provisions for loss on assets are permitted to be classified as
non-operating. Under US GAAP, provisions for loss on assets are classified as
operating. Accordingly, under US GAAP operating income would be decreased by nil
(2006 - $4).
 
 19.           Earnings
per share
 
 (Canadian
      dollars – millions except per share data)
              2007
              2006Numerator:Numerator
      for basic earnings per share:Income
      for the year
              $   1,601
              $    223Distribution
      of Jazz units to preferred shareholders
              (3)
              -Accretion
      of convertible preferred shares (a)
              (19)
              (18)Adjusted
      numerator for earnings per share
              1,579
              205Effect
      of potential dilutive securities:Convertible
      preferred shares (b)
              19
              18Convertible
      notes (b)
              25
              24Add
      back anti-dilutive impact
              -
              (24)Adjusted
      earnings for diluted earnings per share
              $   1,623
              $    223Denominator:Denominator
      for basic earnings per share:Weighted-average
      shares
              103
              102Effect
      of potential dilutive securities:Convertible
      preferred shares
              11
              10Convertible
      notes
              11
              7Stock
      options
              2
              1Add
      back anti-dilutive impact
              -
              (7)Adjusted
      weighted-average shares for diluted earnings per share
              127
              113Basic
      earnings per share
              $   15.26
              $   2.01Diluted
      earnings per share
              $   12.75
              $   1.97
 
 (a)
              Income
      is reduced by the accretion of the convertible preferred shares under US
      GAAP to obtain income available to common share
  holders.
 
 (b)
              The
      adjustment to the numerator under US GAAP is different than the adjustment
      to the numerator under Canadian GAAP due to the difference in the value
      recorded at inception as described in item 2 and the difference in
      accretion rates.
 
 The
calculation of earnings per share is based on whole dollars and not on rounded
millions. As a result, the above amounts may not be recalculated to the per
share amount disclosed above.
 
 20.
Supplementary information under US GAAP
 
 Accounts
payable and accrued liabilities
 
 The
components of accounts payable and accrued liabilities at December 31 are as
follows:
 
 2007
              2006Trade
      payables
              $     237
              $     413Accrued
      liabilities
              164
              203Payroll
      related liabilities
              345
              542Convertible
      notes – embedded derivative (2)
              47
              -Other
              520
              418$  1,313
              $  1,576
    91
  Notes to the
      Consolidated
      Financial Statements2007
 Consolidated
statement of operations
 
 The
components of depreciation, amortization and obsolescence for the years
presented below are as follows:
 
 2007
              2006Depreciation
      of tangible assets
              $     518
              $     467Amortization
      of intangible assets
              81
              103Obsolescence
      provision on spare parts, materials and supplies
              11
              14$     610
              $     584
 
 The
components of other operating expenses for years presented below are as
follows:
 2007
              2006Terminal
      handling and services
              $     185
              $     208Building
      rent and maintenance
              129
              132Flight
      and cabin crew expense
              127
              135Credit
      card fees
              185
              171Miscellaneous
      fees and services
              129
              124Advertising
      and promotion (a)
              65
              90Customer
      maintenance and materials
              130
              125Other
              694
              720$  1,644
              $  1,705
 (a)
              Advertising
      and promotion costs are expensed when
incurred.
 
 Rent
expense
 
 Rent
expense, including aircraft rent, building and other equipment rentals, for the
year ended December 31, 2007 amounts to $456 (2006 - $576).
 
 Valuation
and qualifying accounts and reserves
 
 Balance
      at beginning of year
              Additions
      charged to costs and expenses
              Deductions
      / Other (a)
              Balance
      at end of yearAllowance
      for obsolescence of spare parts, materials and suppliesYear
      ended December 31, 2006
              $       16
              $       14
              $           -
              $       30Year
      ended December 31, 2007
              $       30
              $       11
              $       (40)
              $         1Allowance
      for uncollectible accountsYear
      ended December 31, 2006
              $       13
              $         1
              $         (9)
              $         5Year
      ended December 31, 2007
              $         5
              $       12
              $       (15)
              $         2Future
      income tax valuation allowanceYear
      ended December 31, 2006
              $  2,317
              $          -
              $     (711)
              $  1,606Year
      ended December 31, 2007
              $  1,606
              $          -
              $     (799)
              $     807
 
 (a)
              The
      Allowance for obsolescence of spare parts, materials and supplies -
      Deductions / Other account includes a deduction of $35 arising from the
      monetization of ACTS.
 
 21.           Recently
Issued Accounting Standards
 
 Fair
value measurements
 
 In
September 2006, the FASB issued FASB Statement 157, “Fair Value Measurements”
(“FAS 157”), which defines fair value, establishes a framework for measuring
fair value in generally accepted accounting principles, and expands disclosures
about fair value measurements. This Statement applies under other accounting
pronouncements that require or permit fair value measurements, the Board having
previously concluded in those accounting pronouncements that fair value is the
relevant measurement attribute. Accordingly, this Statement does not require any
new fair value measurements, however, for some entities, the application of this
   92
  Notes to the
      Consolidated
      Financial Statements2007
  Statement
will change current practice. FAS 157 is effective for financial statements
issued for fiscal years beginning after November 15, 2007, and interim periods
within those fiscal years. The Corporation will adopt this standard as of
Quarter 1 2008 and is in the process of assessing the impact of adopting this
standard on the consolidated financial position and results of
operations.
 
 Fair
value option
 
 In
February 2007, the FASB issued FASB Statement 159, “The Fair Value Option for
Financial Assets and Financial Liabilities” (“FAS 159”), which permits an entity
to measure certain financial assets and financial liabilities at fair value.
Under FAS 159, entities that elect the fair value option will report unrealized
gains and losses in earnings at each subsequent reporting date. The fair value
option may be elected on an instrument-by-instrument basis, with few exceptions,
as long as it is applied to the instrument in its entirety. The Corporation will
adopt this standard as of Quarter 1 2008 and is in the process of assessing the
impact of adopting this standard on the consolidated financial position and
results of operations.
 
 Business
combinations
 
 In
December 2007, the FASB issued Statement of Financial Accounting Standards
("FAS") No. 141 (revised 2007), Business Combinations (“FAS 141(R)") which
replaces FAS No.141, Business Combination. FAS 141(R) retains the underlying
concepts of FAS 141 in that all business combinations are still required to be
accounted for at fair value under the acquisition method of accounting but FAS
141(R) changed the method of applying the acquisition method in a number of
significant aspects.
 
 The
significant changes from current practice resulting from FAS 141(R) are
described below:
 
 §
              The
      definitions of a business and a business combination have been expanded,
      resulting in an increased number of transactions or other events that will
      qualify as business combinations.
 §
              For
      all business combinations (whether partial, full, or step acquisitions),
      the entity that acquires the business (the "acquirer") will record 100% of
      all assets and liabilities of the acquired business, including goodwill,
      generally at their fair values.
 §
              Certain
      contingent assets and liabilities acquired will be recognized at their
      fair values on the acquisition
date.
 §
              Contingent
      consideration will be recognized at its fair value on the acquisition date
      and, for certain arrangements, changes in fair value will be recognized in
      earnings until settled.
 §
              Acquisition-related
      transaction and restructuring costs will be expensed rather than treated
      as part of the cost of the acquisition and included in the amount recorded
      for assets acquired.
 §
              In
      step acquisitions, previous equity interests in an acquiree held prior to
      obtaining control will be remeasured to their acquisition-date fair
      values, with any gain or loss recognized in
  earnings.
 §
              When
      making adjustments to finalize initial accounting, companies will revise
      any previously issued post-acquisition financial information in future
      financial statements to reflect any adjustments as if they had been
      recorded on the acquisition date.
 §
              Reversals
      of valuation allowances related to acquired deferred tax assets and
      changes to acquired income tax uncertainties will be recognized in
      earnings, except for qualified measurement period adjustments. (The
      measurement period is a period of up to one year during which the initial
      amounts recognized for an acquisition can be adjusted.) This treatment is
      similar to how changes in other assets and liabilities in a business
      combination will be treated, and different from current accounting under
      which such changes are treated as an adjustment of the cost of the
      acquisition.
 §
              Asset
      values will no longer be reduced when acquisitions result in a "bargain
      purchase"; instead the bargain purchase will result in the recognition of
      a gain in earnings.
 §
              Transition
      provisions for the adoption of FAS 141(R) are prospective (i.e., the
      acquirer shall apply the legacy accounting under FAS 141 and other
      applicable U.S. GAAP for business combinations in which the acquisition
      date is before the effective date of FAS 141(R)) with the exception of
      accounting for changes in a valuation allowance for acquired deferred tax
      assets and the resolution of uncertain tax positions accounted for under
      FIN 48. Aside from measurement period adjustments, the changes in these
      tax items will be recognized in income tax expense rather than as an
      additional cost of the acquisition.
 
 FAS
141(R) is effective on a prospective basis for all business combinations for
which the acquisition date is on or after the beginning of the first annual
period subsequent to December 15, 2008, with the exception of the accounting for
valuation allowances on deferred taxes and acquired tax contingencies. FAS
141(R) amends FAS 109 such that adjustments made to valuation allowances on
deferred taxes and acquired tax contingencies
   93
  Notes to the
      Consolidated
      Financial Statements2007
  associated
with acquisitions that closed prior to the effective date of FAS 141(R) would
also apply the provisions of FAS 141(R). Early adoption is not
allowed.
 
 The
Corporation is currently evaluating the effects, if any, that FAS 141(R) may
have on its financial statements.
 
 Non-controlling
interests in consolidated financial statements
 
 In
December 2007, the FASB issued Statement of Financial Accounting Standards
("FAS") No. 160, Noncontrolling Interests in Consolidated Financial Statements,
an Amendment of ARB 51 (“FAS 160)"). FAS 160 amends ARB 51 to establish new
standards that will govern the accounting for and reporting of (1)
noncontrolling interest in partially owned consolidated subsidiaries and (2) the
loss of control of subsidiaries.
 
 The
following are among the more significant changes from current practice
introduced by FAS 160:
 
 §
              Noncontrolling
      interest (previously referred to as minority interest) will be reported as
      part of equity in the consolidated financial
  statements.
 §
              Losses
      will be allocated to the noncontrolling interest even when such allocation
      might result in a deficit balance, reducing the losses attributed to the
      controlling interest.
 §
              If
      control is maintained, changes in ownership interests will be treated as
      equity transactions. Differences between the fair value of the
      consideration received or paid and the related carrying value of the NCI
      will be recognized in the controlling interest’s
  equity.
 §
              Upon
      a loss of control, any gain or loss on the interest sold will be
      recognized in earnings. Additionally, any ownership interest retained will
      be remeasured at fair value on the date control is lost, with any gain or
      loss recognized in earnings.
 
 FAS 160
is effective on prospective basis for all fiscal years, and interim periods
within those fiscal years beginning, on or after December 15, 2008, except for
the presentation and disclosure requirements, which will be applied
retrospectively. Early adoption is not allowed.
 
 The
Corporation is currently evaluating the effects that FAS 160 may have on its
financial statements.
 
  94
 Notes to the
      Consolidated
      Financial Statements2007
 
 24.
      SUBSEQUENT EVENTS
 
 Substantial
Issuer Bid
  On
January 10, 2008, ACE accepted for purchase and cancellation a total of
40,023,427 Class A Variable Voting Shares and 9,894,166 Class B Voting Shares at
$30.00 per share for an aggregate purchase price of approximately $1.498 billion
in accordance with the terms of a Substantial Issuer Bid launched in December
2007.  No Convertible Preferred Shares of ACE were deposited on an as
converted basis under the offer.
  In
connection with the share purchase and cancellation by ACE, the conversion rate
of ACE's 4.25% Convertible Senior Notes Due 2035 was adjusted from 37.6879 to
39.0341 Class A variable voting shares or Class B voting shares per $1,000
principal amount of convertible notes. The adjustment is effective January 11,
2008 and has been determined in accordance with the terms of the indenture
governing the convertible senior notes
  ACTS
  On
January 14, 2008, the full balance of $40 of funds held in escrow on the closing
of the monetization of ACTS were received by ACE.
  Disposal
of Jazz Air Income Fund units
  On
January 24, 2008 ACE sold a total of 13 million trust units of Jazz Air Income
Fund to certain funds and accounts managed by West Face Capital Inc. and to
Sunrise Partners Limited Partnership at a price of $7.45 per unit representing
total net proceeds to ACE of approximately $96.85. Immediately following the
sale, ACE holds 9.5% of the issued and outstanding units of Jazz Air Income
Fund.
  
 95