Exhibit
99.2











**CONSOLIDATED
FINANCIAL STATEMENTS**











**CALL-NET
ENTERPRISES INC.**











**DECEMBER
31, 2004**




































**AUDITORS'
REPORT**

















To the
Shareholders of


**Call-Net
Enterprises Inc.**





We have
audited the consolidated balance sheets of Call-Net Enterprises Inc. as at
December 31, 2004 and the consolidated statements of operations and deficit and
cash flows for the year ended December 31, 2004. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audit.





We
conducted our audit in accordance with Canadian generally accepted auditing
standards. Those standards require that we plan and perform an audit to obtain
reasonable assurance whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation.





In our
opinion, these consolidated financial statements present fairly, in all material
respects, the financial position of the Company as at December 31, 2004 and
the results of its operations and its cash flows for the year ended December 31,
2004 in accordance with Canadian generally accepted accounting
principles.





The
consolidated financial statements as at December 31, 2003 and for each of the
periods in the two years ended December 31, 2003, prior to adjustment for the
changes in the Company’s accounting policies for Stock-based Compensation and
Asset Retirement Obligations as described in note 2 to the financial statements,
were audited by other auditors who expressed an opinion without reservation on
those statements in their report dated February 13, 2004 (except for note 21
which was dated February 20, 2004). We have audited the adjustments to these
financial statements and, in our opinion, such adjustments, in all material
respects, are appropriate and have been properly applied.








/s/ KPMG,
LLP


Chartered
Accountants





Toronto,
Canada


February
21, 2005











**Call-Net
Enterprises Inc.**





**CONSOLIDATED
BALANCE SHEETS**





As at
December 31


[millions
of Canadian dollars]





**2004**
    
    2003*Restated**[notes
      2, 7]***ASSETS**Cash
      and cash equivalents
    
    
    **38.9**
    
    
    56.5Short-term
      investments
    
    
    **34.8**
    
    
    93.6Cash,
      cash equivalents and short-term investments
    
    
    **73.7**
    
    
    150.1Accounts
      receivable*[note
      3]*
    
    
    **22.8**
    
    
    42.7Other
      current assets*[note
      4]*
    
    
    **30.2**
    
    
    48.9**Total
      current assets**
    
    
    **126.7**
    
    
    241.7Capital
      assets*[note
      5]*
    
    
    **458.3**
    
    
    516.7Intangible
      assets*[note
      6a]*
    
    
    **52.2**
    
    
    68.1Other
      assets*[note
      6b]*
    
    
    **11.7**
    
    
    12.6**Total
      assets**
    
    
    **648.9**
    
    
    839.1**LIABILITIES
      AND SHAREHOLDERS' EQUITY****Accounts
      payable and accrued liabilities***[note
      7]*
    
    
    **149.7**
    
    
    149.4**Long-term
      debt***[note
      8a]*
    
    
    **268.5**
    
    
    387.1**Other
      long-term liabilities***[note 8b]*
    
    
    **53.3**
    
    
    49.1Commitments,
      guarantees and contingencies*[notes
      8, 11 and 12]***Shareholders'
      equity**Capital
      stock*[note
      9]*Common
      shares, unlimited authorized
    
    
    **49.7**
    
    
    49.8Class
      B non-voting shares, unlimited
      authorized
    
    
    **298.5**
    
    
    297.6Preferred
      shares, unlimited authorized
    
    
    **-**
    
    
    -Contributed
      surplus*[notes 2 and 9]*
    
    
    **4.4**
    
    
    2.9Deficit
    
    
    **(175.2**
    **)**
    
    (96.8
    )**Total
      shareholders' equity**
    
    **177.4**
    
    
    253.5**Total
      liabilities and shareholders' equity**
    
    
    **648.9**
    
    
    839.1





*See
accompanying notes*





**On
behalf of the board of directors:**





**Lawrence
      G. Tapp**
    **David
      A. Rattee**Chair
    Director











**Call-Net
Enterprises Inc.**





**CONSOLIDATED
STATEMENTS OF OPERATIONS AND DEFICIT**





Years
ended December 31


[millions
of Canadian dollars, except per share amount or otherwise
indicated]





Pre-recapitalizationNine
    
    ThreeMonths
    
    MonthsEnded
    
    EndedDec
      31,
    
    Mar
      31,**2004**
    
    2003
    
    2002
    
    2002*Restated*
    
    *Restated**[note
      2]*
    
    *[note
      2]***Revenue**
    
    
    **818.6**
    
    
    805.3
    
    
    598.9
    
    
    201.8Carrier
      charges
    
    
    **400.6**
    
    
    409.9
    
    
    335.7
    
    
    116.8**Gross
      profit**
    
    
    **418.0**
    
    
    395.4
    
    
    263.2
    
    
    85.0Operating
      costs
    
    
    **313.1**
    
    
    299.3
    
    
    228.5
    
    
    73.1Realignment,
      restructuring and other charges*[note
      15]*
    
    
    **1.2**
    
    
    7.0
    
    
    30.5
    
    
    -Depreciation
      and amortization*[notes
      5 and 6]*
    
    
    **146.6**
    
    
    157.3
    
    
    120.7
    
    
    41.8**Operating
      loss**
    
    
    **(42.9**
    **)**
    
    (68.2
    )
    
    (116.5
    )
    
    (29.9
    )Net
      gain (loss) on sale of capital assets and rights*[note
      5]*
    
    
    **(0.9**
    **)**
    
    -
    
    
    9.4
    
    
    -Gain
      (loss) on repurchase of long-term debt*[note
      8(a)]*
    
    
    **(4.0**
    **)**
    
    -
    
    
    93.1
    
    
    -Reversal
      of change in control provision*[note 12]*
    
    
    **4.7**
    
    
    -
    
    
    -
    
    
    -Interest
      on long-term debt
    
    
    **(32.7**
    **)**
    
    (43.2
    )
    
    (43.9
    )
    
    (60.3
    )Interest
      and other expense
    
    
    **(13.4**
    **)**
    
    (5.7
    )
    
    (2.9
    )
    
    (0.8
    )Foreign
      exchange gain (loss)
    
    
    **17.1**
    
    
    85.9
    
    
    4.1
    
    
    (1.8
    )**Loss
      before taxes**
    
    
    **(72.1**
    **)**
    
    (31.2
    )
    
    (56.7
    )
    
    (92.8
    )Income
      tax benefit (expense)*[note
      10]*
    
    
    **(6.3**
    **)**
    
    (6.3
    )
    
    (2.6
    )
    
    1.0**Net
      loss for the period**
    
    
    **(78.4**
    **)**
    
    (37.5
    )
    
    (59.3
    )
    
    (91.8
    )**Deficit,
      beginning of period, as previously reported**
    
    
    **(93.0**
    **)**
    
    (57.7
    )
    
    -
    
    
    (2,759.4
    )Adjustment
      for stock-based compensation*[note
      2]*
    
    
    **(2.9**
    **)**
    
    (1.2
    )
    
    -
    
    
    -Adjustment
      for asset retirement obligations *[note 2]*
    
    
    **(0.9**
    **)**
    
    (0.4
    )
    
    -
    
    
    -**Deficit,
      beginning of period, as restated**
    
    
    **(96.8**
    **)**
    
    (59.3
    )
    
    -
    
    
    (2,759.4
    )**Deficit,
      end of period**
    
    
    **(175.2**
    **)**
    
    (96.8
    )
    
    (59.3
    )
    
    (2,851.2
    )**Basic
      and diluted loss per share***[note 16]*
    
    
    **(2.20**
    **)**
    
    (1.36
    )
    
    (2.49
    )
    
    (20.26
    )





*See
accompanying notes*




















**Call-Net
Enterprises Inc.**








**CONSOLIDATED
STATEMENTS OF CASH FLOWS**





Years
ended December 31


[millions
of Canadian dollars]


Pre-recapitalizationNine
    
    ThreeMonths
    
    MonthsEnded
    
    EndedDec
      31,
    
    Mar
      31,**2004**
    
    2003
    
    2002
    
    2002*Restated*
    
    *Restated**[notes
      2 and 17]*
    
    *[note
      2]***OPERATING
      ACTIVITIES**Net
      loss for the period
    
    
    **(78.4**
    **)**
    
    (37.5
    )
    
    (59.3
    )
    
    (91.8
    )Add (deduct)
      operating items not requiring cash:Depreciation
      and amortization
    
    
    **146.6**
    
    
    157.3
    
    
    120.7
    
    
    41.8Unrealized
      foreign exchange (gain) loss on long-term debt
    
    
    **(17.8**
    **)**
    
    (85.9
    )
    
    (4.8
    )
    
    1.8Reversal of
      change in control provision *[note 12]*
    
    
    **(4.7**
    **)**
    
    -
    
    
    -
    
    
    -Loss (gain)
      on repurchase of long-term debt *[note 8(a)]*
    
    
    **4.0**
    
    
    -
    
    
    (93.1
    )
    
    -Income taxes
      *[note 10]*
    
    
    **3.9**
    
    
    4.3
    
    
    -
    
    
    (2.4
    )Other
      non-cash operating expenses
    
    
    **2.7**
    
    
    3.0
    
    
    4.4
    
    
    (0.2
    )Net losses on
      disposals and writedowns of capital assets *[note
    5]*
    
    
    **0.9**
    
    
    -
    
    
    1.3
    
    
    -Realignment,
      restructuring and other charges *[note 15]*
    
    
    **1.2**
    
    
    -
    
    
    -
    
    
    -Interest
      accretion on long-term debt
    
    
    **-**
    
    
    -
    
    
    -
    
    
    35.7Cash provided
      by (used in) operations before changes in non-cash working
    capital
    
    
    **58.4**
    
    
    41.2
    
    
    (30.8
    )
    
    (15.1
    )Net change in
      non-cash working capital balances related to operations *[note
      17]*
    
    
    **28.4**
    
    
    2.5
    
    
    60.3
    
    
    (8.3
    )**Cash
      provided by (used in) operating activities**
    
    
    **86.8**
    
    
    43.7
    
    
    29.5
    
    
    (23.4
    )**INVESTING
      ACTIVITIES**(Increase)
      decrease in short-term investments
    
    
    **58.8**
    
    
    (2.7
    )
    
    12.3
    
    
    217.2Acquisition
      of capital assets*[note
      17]*
    
    
    **(55.4**
    **)**
    
    (44.1
    )
    
    (62.4
    )
    
    (16.0
    )Increase
      in long-term investment*[note
      6]*
    
    
    **(0.2**
    **)**
    
    -
    
    
    -
    
    
    -Net
      proceeds on disposal of capital assets and rights*[note
      5]*
    
    
    **0.4**
    
    
    7.8
    
    
    6.7
    
    
    -Acquisitions*[note
      13]*
    
    
    **(0.5**
    **)**
    
    (19.7
    )
    
    (1.0
    )
    
    -Increase
      in deferred costs
    
    
    **(0.3**
    **)**
    
    (1.0
    )
    
    -
    
    
    (2.6
    )**Cash
      provided by (used in) investing activities**
    
    
    **2.8**
    
    
    (59.7
    )
    
    (44.4
    )
    
    198.6**FINANCING
      ACTIVITIES**Decrease
      in right-of-way liability
    
    
    **(2.4**
    **)**
    
    (2.2
    )
    
    (0.1
    )
    
    (0.1
    )Issuance
      of common shares
    
    
    **-**
    
    
    40.6
    
    
    -
    
    
    -Repurchase
      of long-term debt*[note
      8(a)]*
    
    
    **(104.8**
    **)**
    
    -
    
    
    (29.7
    )
    
    -**Cash
      provided by (used in) financing activities**
    
    
    **(107.2**
    **)**
    
    38.4
    
    
    (29.8
    )
    
    (0.1
    )**Net
      increase (decrease) in cash and cash equivalents during the
      period**
    
    
    **(17.6**
    **)**
    
    22.4
    
    
    (44.7
    )
    
    175.1Cash
      and cash equivalents, beginning of period*[note
      1]*
    
    
    **56.5**
    
    
    34.1
    
    
    78.8
    
    
    15.5**Cash
      and cash equivalents, end of period**
    
    
    **38.9**
    
    
    56.5
    
    
    34.1
    
    
    190.6




*See
accompanying notes*
















**Call-Net
Enterprises Inc.**





**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**





Year
ended December 31, 2004


[millions
of Canadian dollars, unless otherwise indicated]





**1.**
    **BASIS
      OF PRESENTATION**





Call-Net
Enterprises Inc. [the ‘Company’], through its various subsidiaries, including
Sprint Canada Inc., Call-Net Technology Services, Inc., Call-Net Communications
Inc., Call-Net Carrier Services Inc. and AlternaCall Inc., is an alternative
provider of long distance, data, local and wireless telecommunications services
to business and residential customers. The consolidated financial statements of
the Company have been prepared in accordance with Canadian generally accepted
accounting principles [‘Canadian GAAP’]. These principles are also in conformity
in all material respects with United States generally accepted accounting
principles [‘U.S. GAAP’] except as described in note 20.





**Financial
Reorganization**





On April 10, 2002,
the Company completed a Plan of Arrangement pursuant to Section 192 of the
*Canada Business Corporations Act* to surrender all of its $2.6 billion
in principal amount of senior notes and senior discount notes in exchange for
U.S.$377.0 of new 10.625 per cent senior secured notes due 2008, U.S.$81.9 in
cash, and 80 per cent of the equity in the recapitalized company.





The
Plan of Arrangement contemplated a series of steps leading to an overall capital
reorganization of the Company. These included, among other things:





(a)
    the
      amendment of the Company’s authorized share capital to create three new
      classes of shares: common shares, class B non-voting shares and preferred
      shares, and the issuance of these common shares and class B non-voting
      shares in exchange for the pre-recapitalization shares;(b)
    the
      creation and issuance of the senior secured notes and the issuance of the
      common shares and the class B non-voting shares in exchange for the
      pre-recapitalization notes;(c)
    the
      cancellation of all pre-recapitalization notes, shares, options,
      entitlements and the termination of the pre-recapitalization stock option
      plan;(d)
    the
      consolidation of the common shares on a one for 20 basis and the
      consolidation of the class B non-voting shares on a one for 20
      basis;(e)
    the
      adoption of the new Incentive Stock Option Plan [‘Option Plan’],
      Shareholders’ Rights Plan [‘Rights Plan’] and Restricted Stock Unit Plan
      [‘RSUP’]; and(f)
    the
      reduction and determination of the Company’s stated capital in accordance
      with the Plan of Arrangement.





**Fresh Start
Accounting**





Pursuant to the
Plan of Arrangement, there was a substantial realignment of the equity and
non-equity interests of the Company on April 10, 2002. For accounting purposes,
the Company has used an effective date of April 1, 2002. The Company’s
consolidated balance sheet as at April 1, 2002 was prepared on a fresh start
basis after giving effect to the Plan of Arrangement in accordance with the
Canadian Institute of Chartered Accountants [‘CICA’] Section 1625,
’Comprehensive Revaluation of Assets and Liabilities’. Under fresh start
accounting, the Company’s assets and liabilities were recorded at management’s
best estimate of their fair values and the deficit was eliminated by a reduction
of capital stock. The book values





1





**Call-Net
Enterprises Inc.**

**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**

Year
ended December 31, 2004
[millions
of Canadian dollars, unless otherwise indicated]


of assets and
liabilities at April 1, 2002 approximated their fair values, with the exception
of capital assets and future tax liabilities. Independent third party analysis
was used by management to arrive at the fair value of capital assets. Future tax
liabilities were valued based on the temporary differences and tax losses that
were available to the Company.





The completion of
the Company’s capital reorganization and comprehensive revaluation of assets and
liabilities under fresh start accounting had the following effects:





****Apr
      1, 2002****
    
    
    
    **Writedowns**
    
    **Apr
      1, 2002******Balance****
    
    **Re-**
    
    **and**
    
    **Balance****prior
      to re-**
    
    **capitalization**
    
    **fresh
      start**
    
    **after****capitalization**
    
    **adjustments**
    
    **adjustments**
    
    **adjustments****ASSETS**Cash
      and cash equivalents
    
    
    190.6
    
    
    (111.8
    )(1)(2)(3)
    
    -
    
    
    78.8Short-term
      investments
    
    
    103.2
    
    
    -
    
    
    -
    
    
    103.2Accounts
      receivable
    
    
    110.6
    
    
    -
    
    
    -
    
    
    110.6Other
      current assets
    
    
    58.4
    
    
    (2.0
    )(3)
    
    -
    
    
    56.4Capital
      assets
    
    
    736.2
    
    
    -
    
    
    (89.7
    )(4)
    
    646.5Other
      assets
    
    
    166.1
    
    
    (45.9
    )(5)
    
    (0.1
    )
    
    120.1**Total
      assets**
    
    
    **1,365.1**
    
    
    **(159.7**
    **)**
    
    **(89.8**
    **)**
    
    **1,115.6****LIABILITIES**Accounts
      payable and accrued liabilities
    
    
    182.9
    
    
    (13.1
    )(6)
    
    -
    
    
    169.8Future
      income tax liability
    
    
    34.4
    
    
    -
    
    
    (34.4
    )
    
    -Long-term
      liabilities
    
    
    2,662.9
    
    
    (2,023.4
    )(1)
    
    -
    
    
    639.5SHAREHOLDERS'
      EQUITY (DEFICIENCY)Capital
      stock
    
    
    -
    
    
    1,342.6
    (1)(2)(3)
    
    (1,036.3
    )
    
    306.3Pre-recapitalization
      capital stock
    
    
    1,336.1
    
    
    (1,336.1
    )(1)
    
    -
    
    
    -Deficit
    
    
    (2,851.2
    )
    
    1,870.3
    (7)
    
    980.9
    
    
    -**Total liabilities and
      shareholders' equity (deficiency)**
    
    
    **1,365.1**
    
    
    **(159.7**
    **)**
    
    **(89.8**
    **)**
    
    **1,115.6**





(1)
    Under the
      Plan of Arrangement, the noteholders received a combination
      of:a.
    U.S.$72.7 of
      cash on the effective date of the transaction in addition to U.S.$9.2 paid
      in February 2002.b.
    shares equal
      to approximately 80 per cent of the equity of the recapitalized Company,
      andc.
    U.S.$377.0
      senior secured notes due 2008.Determined in
      each case on a pro rata basis, with respect to each noteholder, by the
      ratio equal to the dollar value of the accreted principal plus interest as
      of December 31, 2001 of the pre-recapitalization notes owned by such
      noteholder divided by the total pre-recapitalization note
      value.(2)
    Immediately
      after the Plan of Arrangement, Sprint Communications Company L.P.
      [‘Sprint’] invested $25.0 in exchange for five per cent of the
      post-recapitalization equity of the Company. Sprint also received $4.9 for
      the royalty payment relating to the three months ended March 31, 2002.





2




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]





(3)
    Costs
      directly incurred to effect the recapitalization that were paid in advance
      of the effective date of the transaction totaling $2.0 were transferred to
      capital stock. In addition, the opening cash and cash equivalents balance
      was adjusted for $16.5 of transaction costs to be paid on the completion
      of the transaction.(4)
    Prior to the
      application of fresh start accounting, the Company performed an assessment
      for impairment of the carrying values of its long-lived assets. Based on
      this assessment, assets available for sale of $78.6 were written down to
      nil. The value of capital assets was further reduced by $11.1 as part of
      the implementation of fresh start accounting.(5)
    The write-off
      of the unamortized balance of deferred financing costs, trademarks, as
      well as technology and product rights associated with the prior agreement
      with Sprint.(6)
    Under the
      Plan of Arrangement, the accrued interest on all pre-recapitalization
      notes was eliminated and interest on the senior secured notes due 2008 was
      accrued for the period from January 1, 2002 to March 31,
    2002.(7)
    The Company
      used unrecorded tax loss carryforward balances of approximately $1,533
      against the gain on retirement of the long-term
debt.




**2.**
    **SUMMARY
      OF SIGNIFICANT ACCOUNTING
POLICIES**





**Accounting
Changes**





*Stock-Based
Compensation and Other Stock-Based Payments*





Effective
January 1, 2004, the Company adopted the changes made to CICA Section 3870,
‘Stock-Based Compensation and Other Stock-Based Payments’ requiring that all
stock-based compensation awarded to both employees and non-employees be measured
and recognized using the fair value method. Previously, the Company had elected
to use the settlement method to account for stock option grants to employees.
The main impact for the Company was to measure and recognize compensation
expense using the fair value method relating to the award of stock options to
employees that the Company had previously chosen to disclose on a pro forma
basis within the notes to the financial statements. The
Company adopted this change on a retroactive basis with restatement of prior
periods to reflect the expensing of the fair value of stock options granted
subsequent to January 1, 2002. The result of this change is reflected in
operating expenses in the consolidated statements of operations and deficit and
contributed surplus and capital stock on the consolidated balance sheets. The
effect of the prior-period restatements was an increase to net loss for the year
ended December 31, 2003 and nine months ended December 31, 2002 of $1.7 and $1.2
respectively, with corresponding increases to deficit of $2.9 as at December 31,
2003. The impact of the restatement increased both basic and diluted loss per
share by $0.06 and $0.05, respectively, for the same periods.




*Asset
Retirement Obligations*





Effective
January 1, 2004, the Company retroactively adopted, with restatement of prior
periods, the new CICA Handbook Section 3110, ‘Asset Retirement Obligations’
[‘ARO’], which establishes standards for the





3




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


recognition,
measurement and disclosure of liabilities for asset retirement obligations and
the associated retirement costs. This section applies to legal obligations
associated with the retirement of tangible long-lived assets that results from
their acquisition, lease, construction, development or normal operation. The
offset to the initial ARO is an increase in the carrying amount of the related
long-lived asset. Over time, the liability is accreted to its future value, and
the asset is depreciated over the useful life of the related asset. The
accretion expense related to the ARO is recorded in depreciation and
amortization expense within the consolidated statements of operations and
deficit. Upon settlement of the liability, an entity either settles the
obligation for its recorded amount or incurs a gain or loss upon settlement.
This standard was effective on a retroactive basis with restatement of prior
periods.





The
Company has reviewed its obligations and determined that it has AROs associated
with retiring fibre optic cable and leasehold improvement assets at the maturity
of the facility leases. As at January 1, 2004, the cumulative effect of the
retroactive adjustment was an increase to fibre optic cable assets and leasehold
improvements of $1.5, an increase to other long-term liabilities of $2.4, and an
increase to opening deficit of $0.9. The prior period restatement increased
depreciation expense and net loss for the year ended December 31, 2003 and nine
months ended December 31, 2002 by $0.5 and $0.4 respectively. The impact of the
restatement also increased both basic and diluted loss per share by $0.02 and
$0.02, respectively, for the same periods.





*Impairment
of Long-Lived Assets*





Effective
January 1, 2004, the Company adopted, on a prospective basis, the guidance in
CICA Section 3063, ’Impairment of Long-Lived Assets‘. Under Section 3063, an
impairment loss is recognized on a long-lived asset held for use when its
carrying value exceeds the undiscounted cash flows from its use and eventual
disposition. The amount of the loss is measured by deducting the asset’s fair
value (based on discounted cash flows when quoted market prices are not
available) from its carrying value. Prior to the adoption of Section 3063, an
impairment loss was measured by deducting the asset’s net recoverable value
(based on undiscounted cash flows) from its carrying value. Adoption of Section
3063 did not have an impact on results of operations during the current year,
however, it could impact the measurement of an impairment loss in the future.





*Revenue
Recognition*





Effective
January 1, 2004, the Company adopted the CICA’s Emerging Issues Committee
Abstract 141, ’Revenue Recognition‘ [‘EIC 141’]. EIC 141 incorporates the
principles in the Securities and Exchange Commission’s [‘SEC’] Staff Accounting
Bulletin [‘SAB’] 101, ’Revenue Recognition in Financial Statements‘ which has
been since superceded by SAB 104 ‘Revenue Recognition’. The Company has reviewed
its policies and determined there was no impact as a result of the Company
adopting this guidance.





Also
effective January 1, 2004, the Company adopted, on a prospective basis, EIC 142,
’Revenue Arrangements with Multiple Deliverables‘ [‘EIC 142’]. EIC 142 addresses
how to determine whether an arrangement involving multiple deliverables contains
more than one unit of accounting. EIC 142 also addresses how arrangement
consideration should be measured and allocated to the separate units of
accounting in the arrangement. The Company has reviewed its policies and
determined there was no impact as a result of the Company adopting this
guidance.








4




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]
  ****


**Recently
Issued Accounting Pronouncements**





*Vendor
Rebates*





In
January 2005, the CICA amended EIC-144, ‘Accounting by a customer (including a
reseller) for certain consideration received from a vendor.’ The standard is
effective retroactively for periods commencing on or after February 15, 2005.
The standard requires companies to recognize the benefit of non-discretionary
rebates for achieving specified cumulative purchasing levels, as a reduction of
the cost of purchases over the relevant period, provided the rebate is probable
and reasonably estimatable. Otherwise, the rebates would be recognized as
purchasing milestones are achieved. The Company is assessing the impact of the
new standard but does not expect it to have a material impact on the
consolidated financial statements.





**Principles
of Consolidation**





The
consolidated financial statements include the accounts of the Company and its
wholly-owned subsidiaries. All significant intercompany balances and
transactions have been eliminated on consolidation.





Short-term
Investments




Short-term
investments are recorded at the lower of cost and market value. Short-term
investments include investments with original maturities of 90 days or greater.
Investments with maturities less than 90 days are classified as cash and cash
equivalents.





**Allowance
for Doubtful Accounts**





The Company uses a
predictive model as well as specific assessment to determine the allowance
required for doubtful accounts and to estimate the fair value of the retained
interest in securitized receivables.**An industry accepted
predictive model that is representative of the Company’s own experience is
applied to the accounts receivable for the consumer portion of the business. In
other areas, a more detailed review of the accounts receivable balances and
specific customer circumstances is performed at each month-end. Management
experience and knowledge is used to determine overall reserve amounts in this
area.





**Sale of
Receivables**





Transfers of
receivables in securitization transactions are recognized as sales when the
Company is deemed to have surrendered control over the transferred receivables
and consideration other than for its retained interest in the transferred
receivables has been received. When the Company sells its receivables, it
de-recognizes all receivables sold, recognizes at fair value the assets received
and liabilities incurred, and records the gain or loss on sale in ’Interest and
other income (expense)’. Such gain or loss depends in part on the allocation of
the previous carrying amount of the receivables transferred which is allocated
between the receivables sold and the Company’s retained interest in the
receivables transferred based on their relative fair value at the date of
transfer. The Company estimates the fair value of its retained interest based on
the expected cash flows to be realized from the retained interest using
management’s best estimates of the credit losses. Retained interests are
initially recorded





5





**Call-Net
Enterprises Inc.**

**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**

Year
ended December 31, 2004
[millions
of Canadian dollars, unless otherwise indicated]





at their allocated
carrying amount. Any subsequent impairment in the value of the retained
interest, other than a temporary decline, is recorded as a reduction to
income.





Capital
Assets





Capital
assets are recorded at cost. Direct labour and overhead costs incurred to
develop or construct new assets or upgrade existing assets are capitalized.
Indirect overhead costs, general and administrative costs and interest costs are
not capitalized. Depreciation on all assets commences when the assets are put
into service. Depreciation and amortization are being provided based on the
estimated useful lives of the assets on a straight-line basis as
follows:





Multiplex
      and telephone switch equipment
    10
      yearsFibre
      optic cable
    20
      yearsComputer
      equipment and software
    3
      yearsBuildings
    15
      to 40 yearsLeasehold
      improvements
    term
      of the leaseFurniture
      and fixtures
    5
      years





Capital
assets associated with the Company’s network assets are subject to technological
risks and market changes due to new products and changing customer needs. These
changes may result in changes to the estimated useful lives of the related
assets.





Fibre
optic cable acquired under an indefeasible right of use [‘IRU‘] agreement is
included in capital assets provided the criteria for capital treatment has been
met.





**Long-term
Investments**





Long-term
investments are recorded at cost**.**A decline in the value of an
investment that is considered to be other than a temporary impairment in value
is charged against income in the period that such determination is
made.****




**Intangible
and Other Assets**





Customer
relationships and other assets are recorded at cost. Amortization of intangible
and other assets is provided on a straight-line basis as follows:





Customer
      relationships
    30
      months to 8 yearsDeferred
      costs
    as
      related revenue is earned








6


**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]




**Impairment
of long-lived assets**





The
carrying values of long-lived assets to be held and used, including capital
assets and intangible assets with definite useful lives, are reviewed for
impairment whenever events or changes in circumstances indicate that the
carrying values may not be recoverable. Intangible assets with a definite useful
life are also assessed for impairment at least annually. An impairment loss is
recognized when the carrying value exceeds the projected undiscounted future
cash flows expected from its use and disposal, and is measured as the amount by
which the carrying value of the asset exceeds its fair value.





**Revenue
Recognition**





Substantially
all of the Company's revenues are derived from long distance, data, local,
enhanced voice and wireless telecommunications services. Products and services
are sold either stand-alone or together as a multiple service arrangement or a
bundled solution. Components of multiple service arrangements are separately
accounted for provided the delivered elements have stand-alone value to the
customer and the fair value of any undelivered elements can be objectively and
reliably determined.





The
Company recognizes revenue once persuasive evidence of an arrangement exists,
delivery has occurred or services have been rendered, fees are fixed or
determinable and collectability is reasonably assured. The
Company records provisions against related revenue for service discounts,
promotions, achievement credits and incentives related to telecommunication
services. These revenue allowances are based on estimates derived from factors
that include, but are not limited to, historical results, current economic
trends and changes in demand. The provisions for revenue adjustments are
recorded as a reduction of revenue when incurred or ratably over a contract
period.





Revenues
from telecommunication services are recognized based on either customer usage as
measured by the Company's switches or by contractual agreement when provided.
Revenues from the sale of goods are recognized when goods are delivered and
accepted by customers.





Where
services to certain customers are provisioned through the use of subcontractor
agents, revenue is recognized based on the fees charged to the customer provided
that the Company is acting as the principal in the arrangement.





**Expense
Recognition**





Carrier
charges are incurred for the transmission of voice and data over other carriers’
networks. These costs consist of both fixed payments and variable amounts based
on actual usage and negotiated or regulated contract rates. The Company records
carrier charges as incurred. Accordingly, at each balance sheet date, the
Company records its best estimate of the carrier charges incurred but not billed
based on internal usage reports and, for disputed amounts, a reserve based on an
analysis of the probability of paying the disputed amount.





Sales,
marketing and other operating expenses are recognized as incurred. The Company
expenses equipment subsidies related to the acquisition of new wireless service
customers upon activation.








7





**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]




**Stock-based
Compensation**





The
Company has three stock-based compensation plans *[note
9].* The
Company accounts for stock-based compensation using the fair value method. The
fair value of stock options is estimated at the grant date using the
Black-Scholes options pricing model. This model requires the input of a number
of assumptions including dividend yields, expected stock price volatility,
expected life of the option and risk-free interest rates. Although the
assumptions used reflect management’s best estimates, they involve uncertainties
based on market conditions generally outside of the control of the Company. The
estimated fair value of the options is amortized to expense on a straight-line
basis over the vesting period of the option. Stock-based compensation expense is
recorded in operating costs in the Company’s statement of operations and
deficit, and credited to contributed surplus on the balance sheet, until the
award is exercised, at which time it is transferred to capital stock.





Stock-based
awards that are settled or may be settled in cash or shares purchased on the
open market at the option of employees or directors, are recorded as
liabilities. The measurement of the liability and compensation cost for these
awards is based on the intrinsic value of the award, determined based on the
market price of the underlying shares as applicable at each balance sheet date.
Compensation cost determined is recognized over the vesting period of the award.
Under the Restricted Stock Unit Plan [‘RSUP’], the Company recognizes
compensation expense based on the current market value of the underlying shares.
Under the Deferred Share Unit Plan [‘DSUP‘], c ompensation
expense is recognized in the amount of the participants’ remuneration as their
services are provided. Changes in the payment obligation subsequent to vesting
of the award and prior to the settlement date are recorded into operating costs
in the consolidated statements of operations and deficit each period.





**Translation
of Foreign Currencies**





Foreign currency
transactions entered into by the Company and the accounts of its foreign
subsidiaries are translated into Canadian dollars using the temporal method.
Under this method, monetary assets and liabilities in foreign currencies are
translated into Canadian dollars at the year-end rate of exchange and any gains
or losses are reflected in income. Capital and other non-monetary assets are
translated at rates prevailing at the time of the transaction. Revenues and
expenses are translated into Canadian dollars at the rate of exchange prevailing
at the time of the transaction, except for depreciation and amortization, which
are translated at exchange rates prevailing when the related assets were
acquired. Long-term debt denominated in foreign currencies is translated into
Canadian dollars at the year-end rate of exchange. Exchange gains or losses on
translating this long-term debt are reflected in income*.*





**Income
Taxes**





Income
taxes are accounted for using the asset and liability method of tax allocation
accounting. Temporary differences arising from the difference between the tax
basis of an asset or liability and its carrying amount on the balance sheet are
used to calculate future income tax liabilities or assets. Future income tax
liabilities or assets are calculated using substantively enacted tax rates
anticipated to apply in the periods that the temporary differences are expected
to reverse. The effect of a change in income tax rates on future income tax
liabilities or assets is recognized as income in the period that the change
occurs. When necessary, a valuation allowance is recorded to reduce future
income tax assets to an amount that is, in the opinion of management, more
likely than not to be realized.








8




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]
  ****


**Earnings
(Loss) Per Share**





Basic
earnings (loss) per common share is calculated by dividing the net income (loss)
by the weighted-average number of common shares and class B non-voting shares
outstanding during the period after recapitalization. Diluted earnings (loss)
per common share is calculated by dividing the applicable net income (loss) by
the sum of the weighted-average number of common shares and class B non-voting
shares outstanding and all additional common shares that would have been
outstanding if potentially dilutive common shares had been issued during the
period. The treasury stock method is used to compute the dilutive effect of
stock options and similar instruments.





**Use
of Estimates**





The
preparation of consolidated financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the year. Actual results could differ from those estimates. Significant
estimates include allowances for doubtful accounts, provisions for accrued
liabilities, and carrier cost accrual and dispute provisions.







**Comparative
Figures**





Comparative
consolidated financial statements for periods prior to April 1, 2002 have been
presented pursuant to regulatory requirements. In reviewing the comparative
consolidated financial statements, readers are reminded that they do not reflect
the effects of the financial reorganization or the application of fresh start
accounting described in note 1.





Certain prior years
figures have been reclassified to conform to the current year
presentation.





**3.**
    **ACCOUNTS
      RECEIVABLE**


**2004**
    
    2003Trade
      receivables
    
    
    **27.5**
    
    
    46.5Other
    
    
    **0.6**
    
    
    2.4Allowance
      for doubtful accounts
    
    
    **(5.3**
    **)**
    
    (6.2
    )**22.8**
    
    
    42.7





**Accounts
Receivable Securitization Program**





In 2003, the
Company entered into a five-year accounts receivable securitization program
permitting it to sell on an on-going basis, an undivided co-ownership interest
in certain of its trade receivables to a securitization trust (the ‘Trust’) to a
maximum of $55.0, which was fully utilized as at December 31, 2004 (2003 -
$10.0). The total amount transferred to the Trust as at December 31, 2004 was
$82.3 (2003 - $56.0). The Company remains exposed to certain risks of default on
the amount of the receivables under securitization. The Company retains ongoing
servicing responsibilities, and has a retained interest in the securitized
receivables and rights to future excess cash flows generated by the Trust. The
sales are on a fully-serviced basis and the Company does not receive any fees
for its on-going servicing responsibilities. The servicing liability as at
December 31, 2004 was $0.3 (2003 - $0.3). The Trust and its investors have





9





**Call-Net
Enterprises Inc.**

**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**

Year
ended December 31, 2004
[millions
of Canadian dollars, unless otherwise indicated]





no recourse on the
Company’s other assets for failure of debtors to pay when due, other than the
retained interest of the Trust.





During the year
ended December, 2004, the Company recognized a loss of $9.8 (2003 - $3.6) on the
securitization of receivables, and a loss on servicing of $nil (2003 - $0.3).
The Company measures the loss on securitization by applying the same methodology
used to estimate the allowance for doubtful accounts. The result is a provision
for anticipated credit losses of approximately one per cent. The sensitivity of
the current fair value of the retained interest to a 10 to 20 per cent adverse
change in this assumption is not material.





Cash flows from the
securitization for the year are as follows:





**2004**
    
    2003Proceeds from
      new securitizations during the year
    
    
    **45.0**
    
    
    10.0Proceeds from
      collections reinvested during the year
    
    
    **478.8**
    
    
    85.8Proceeds from
      collections pertaining to the retained interest during the
      year
    
    
    **215.9**
    
    
    162.2




**4.**
    **OTHER
      CURRENT ASSETS**


**2004**
    
    2003Retained
      interest in securitized receivables
    
    
    **24.8**
    
    
    41.2Other
    
    
    **5.4**
    
    
    7.7**30.2**
    
    
    48.9





**5.**
    **CAPITAL
      ASSETS**


**2004**
    
    2003**Net**
    
    
    
    
    
    Net**Accumulated**
    
    **Book**
    
    
    
    Accumulated
    
    Book**Cost**
    
    **Depreciation**
    
    **Value**
    
    Cost
    
    Depreciation
    
    ValueMultiplex
      and telephone switch equipment
    
    
    **491.4**
    
    
    **197.6**
    
    
    **293.8**
    
    
    467.4
    
    
    128.8
    
    
    338.6Fibre
      optic cable
    
    
    **109.8**
    
    
    **19.9**
    
    
    **89.9**
    
    
    107.2
    
    
    12.9
    
    
    94.3Computer
      equipment and software
    
    
    **175.1**
    
    
    **121.7**
    
    
    **53.4**
    
    
    144.8
    
    
    87.1
    
    
    57.7Buildings
    
    
    **14.1**
    
    
    **1.1**
    
    
    **13.0**
    
    
    14.1
    
    
    0.7
    
    
    13.4Leasehold
      improvements
    
    
    **12.2**
    
    
    **9.5**
    
    
    **2.7**
    
    
    12.0
    
    
    6.3
    
    
    5.7Furniture
      and fixtures
    
    
    **10.4**
    
    
    **5.4**
    
    
    **5.0**
    
    
    10.4
    
    
    3.9
    
    
    6.5Land
    
    
    **0.5**
    
    
    **-**
    
    
    **0.5**
    
    
    0.5
    
    
    -
    
    
    0.5**813.5**
    
    
    **355.2**
    
    
    **458.3**
    
    
    756.4
    
    
    239.7
    
    
    516.7








10





**Call-Net
Enterprises Inc.**

**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**

Year
ended December 31, 2004
[millions
of Canadian dollars, unless otherwise indicated]





Details
of depreciation expense are as follows:





Pre-recapitalizationNine Months
      Ended
    
    Three Months
      Ended**2004**
    
    2003
    
    Dec 31,
      2002
    
    Mar 31,
      2002Depreciation
      on capital assets
    
    
    **116.4**
    
    
    129.7
    
    
    102.2
    
    
    33.2Accretion
      expense on ARO liability
    
    
    **0.2**
    
    
    0.2
    
    
    0.2
    
    
    -**116.6**
    
    
    129.9
    
    
    102.4
    
    
    33.2





Included in capital
assets are assets under construction and not yet being depreciated of $19.6
(2003 - $18.0).





Included in fibre
optic cable assets are right-to-use fibres under IRU agreements with original
terms extending to 20 years and net book value totalling $3.2 (2003 -
$3.3).





In 2004, the
Company disposed of network access servers having a net book value of $1.3 for
proceeds of $0.4, for a loss on sale of $0.9.





In 2003, the
Company entered into an agreement to provide an indefeasible right of use for
fibre optic cable having a net book value of $0.5 for proceeds of $0.8, and to
provide certain maintenance services. The Company also entered into an agreement
to dispose of fibre optic cable having a net book value of $2.3 and to provide
certain maintenance services. Related expenses to complete the agreement were
$0.1 and proceeds were $3.6. The resulting gains on disposal of $0.3 and $1.2,
respectively, will be recognized ratably over the 20-year term of the service
agreements.





In 2003, the
Company also disposed of a customer call centre and capital assets having a book
value of $0.6 and related expenses of $0.3 for proceeds of $0.9, and equipment
having a net book value of $0.3 for proceeds of $0.3, resulting in no net gain
or loss.





In 2002, the
Company reached an agreement to settle several contingencies relating to asset
transfers made in previous years. As a result of this settlement, the Company
received cash proceeds of $4.4 and has recorded a gain of $4.9. The Company also
disposed of certain intangible rights under a licensing agreement for cash
proceeds of $2.3, and a receivable of $2.2, resulting in a gain of $4.5.





11





**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


**6.**
    **INTANGIBLE AND
      OTHER ASSETS****(a)**
    **Intangible
      Assets**




**2004**
    
    2003**Accumulated**
    
    **Net
      Book**
    
    
    
    Accumulated
    
    Net
      Book**Cost**
    
    **Amortization**
    
    **Value**
    
    Cost
    
    Amortization
    
    ValueCustomer
      relationships
    
    
    **126.7**
    
    
    **74.5**
    
    
    **52.2**
    
    
    113.8
    
    
    45.7
    
    
    68.1





Details of
amortization expense are as follows:





Pre-recapitalizationNine
      Months
    
    Three
      MonthsEnded
    
    EndedDec
      31,
    
    Mar
      31,**2004**
    
    2003
    
    2002
    
    2002Amortization
      of customer relationships
    
    
    **30.0**
    
    
    27.4
    
    
    18.3
    
    
    8.6





Amortization
expense for the next five years is expected to be as follows:


2005
    
    
    32.32006
    
    
    17.22007
    
    
    2.72008
    
    
    -2009
    
    
    -52.2


In 2004, the
Company acquired significant portions of 360networks Corporation’s customer base
from Bell Canada *[note 13]* for $17.6 which was recorded as customer
relationships intangible assets*.*





Also in 2004, the
Company recorded a reduction of its customer relationships amounting to $3.9
relating to the utilization of previously unrecognized tax benefits that arose
prior to the application of fresh start accounting *[note
10]*.





In 2004, the
Company recorded an impairment loss on its customer relationships amounting to
$0.5 (cost of $1.2 and accumulated depreciation of $0.7) due to the loss of a
customer group related to the Mosaic Performance Solutions Canada [‘MPS Canada’]
Acquisition *[note 13]*. This impairment loss was recorded in
amortization expense.





Also in 2004, the
Company recorded other adjustments increasing the cost base of its customer
relationships by $0.4.








12





**Call-Net
Enterprises Inc.**

**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**

Year
ended December 31, 2004
[millions
of Canadian dollars, unless otherwise indicated]


During 2003, the
Company acquired customer relationships valued at $13.7. In addition, the
Company recorded a reduction of $4.3 to the customer relationships amount
recorded at the time of fresh start accounting relating to the utilization of
previously unrecognized tax benefits that arose prior to that date.





**(b)**
    **Other
      Assets**
  **2004**
    
    2003Prepaid
      right-of-way
    
    
    **5.9**
    
    
    6.9Deferred
      costs and other assets
    
    
    **5.2**
    
    
    5.3Investment,
      at cost
    
    
    **0.6**
    
    
    0.4**11.7**
    
    
    12.6





Details of
amortization expense are as follows:





Pre-recapitalizationNine
    
    ThreeMonths
    
    MonthsEnded
    
    EndedDec
      31,
    
    Mar
      31,**2004**
    
    2003
    
    2002
    
    2002Amortization
      of deferred costs recorded as carrier charges
    
    
    **1.3**
    
    
    2.3
    
    
    3.3
    
    
    -


**7.**
    **ACCOUNTS
      PAYABLE AND ACCRUED
LIABILITIES**





**2004**
    
    2003Accrued
      liabilities and trade payables
    
    
    **74.1**
    
    
    62.6Carrier
      payables
    
    
    **37.7**
    
    
    49.5Commodity,
      capital and income tax liabilities
    
    
    **18.8**
    
    
    19.6Payroll
      related liabilities
    
    
    **13.4**
    
    
    14.8Other
    
    
    **5.7**
    
    
    2.9**149.7**
    
    
    149.4





Effective January
1, 2004, the Company reclassified the long-term portion of its deferred fibre
maintenance charge and lease exit costs to long-term liabilities from accounts
payable and accrued liabilities *[note 8b].* The comparative figures have
been restated to conform to this presentation.





13





**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]




**8.**
    **LONG-TERM
      DEBT AND OTHER LONG-TERM
  LIABILITIES****(a)**
    **Senior
      Secured Notes due 2008**





Interest
      Rate
    
    **2004**
    
    2003Senior
      secured notes due 2008
    
    
    10.625
    %
    
    **268.5**
    
    
    387.1





During
the three months ended March 31, 2004, the Company purchased for cancellation a
total of U.S.$76.4 (CDN$100.8) of the outstanding senior secured notes due 2008
at market prices. The total cost of this purchase to the Company was $104.8
resulting in a loss of $4.0.





During
2002, the Company purchased for cancellation a total of U.S.$77.5 of the
outstanding U.S.$377.0 Senior Secured Notes due 2008 at market prices. The total
cost of these purchases to the Company was $29.7 resulting in a gain of
$93.1 *.*





The
Company’s remaining outstanding U.S.$223.1 senior secured notes mature on
December 31, 2008. The senior secured notes were issued in 2002 at approximately
par value and are collateralized by substantially all of the assets of the
Company.





The
senior secured notes bear interest at 10.625 per cent per annum from December
31, 2001, or from the most recent date to which interest has been paid or
provided for, payable semi-annually on June 30 and December 31 in each year,
commencing June 30, 2002. Interest will be computed on the basis of a 360-day
year consisting of twelve 30-day months.





The
senior secured notes are senior secured obligations of the Company and will rank *pari
passu* in
right of payment to any future senior unsecured debt and senior to the Company’s
future subordinated secured debt. The senior secured notes are governed by a
trust indenture which contains certain covenants which, among other things,
restrict the ability of the Company to incur additional indebtedness, consummate
certain sales of assets, make certain investments, engage in sale-leaseback
transactions, pay dividends or repurchase the Company’s capital stock.





On or
after January 1, 2006, the senior secured notes will be redeemable, at the
Company’s option, in whole or in part, at any time or from time-to-time at the
following redemption prices, plus accrued and unpaid interest to the redemption
date: if redeemed during the 12-month period commencing on January 1, 2006
at 105.313 per cent, January 1, 2007 at 102.657 per cent and January 1, 2008 and
thereafter at 100 per cent of the principal amount.





In the
event of a change of control, the Company is required to offer to purchase all
outstanding notes at a purchase price of 101 per cent of their principal amount
plus accrued and unpaid interest to the date of purchase.





14





**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]




**(b)**
    **Other
      Long-Term Liabilities**





Interest
      Rate
    
    **2004**
    
    2003Right-of-way
      liability (i)
    
    
    10.0
    %
    
    **38.3**
    
    
    37.0Customer
      list liability*[note
      13]*
    
    
    N/A
    
    
    **10.0**
    
    
    -Lease
      exit costs*[note
      15]*
    
    
    N/A
    
    
    **2.8**
    
    
    3.7Asset
      retirement obligations (ii)
    
    
    10.0
    %
    
    **2.2**
    
    
    2.4Deferred
      fibre maintenance charge*[note
      15]*
    
    
    N/A
    
    
    **-**
    
    
    6.0**53.3**
    
    
    49.1





Effective January
1, 2004, the Company reclassified the long-term portion of its deferred fibre
maintenance charge and lease exit costs to long-term liabilities from accounts
payable and accrued liabilities *[note 7].* The comparative figures have
been restated to conform to this presentation.


(i)
    Right-of-way
      Liability





The right-of-way
liability represents the net present value of payments to be made under
right-of-way agreements with terms ranging from one to 20 years. The associated
assets for the right-of-ways are recorded in capital assets.





The
future payments for the next five years and thereafter are as
follows:





2005
    
    
    5.32006
    
    
    5.22007
    
    
    5.12008
    
    
    5.12009
    
    
    5.7Thereafter
    
    
    51.2Total
      future minimum payments
    
    
    77.6Less
      imputed interest at 10%
    
    
    (38.0
    )39.6Less
      current portion included in accounts payable
    
    
    (1.3
    )38.3








15




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]




(ii)
    Asset
      Retirement Obligations





The
undiscounted amount of the estimated cash flows required to settle the ARO is
$10.3. The present value of the asset retirement obligation was calculated using
a credit adjusted discount rate of 10 per cent over a weighted-average period of
50 years.





The
following table details the changes in the asset retirement
liability:





**April
      1, 2002**
    
    
    **2.0**Accretion
      charges recorded in depreciation expense
    
    
    0.2**December
      31, 2002**
    
    
    **2.2**Accretion
      charges recorded in depreciation expense
    
    
    0.2**December
      21, 2003**
    
    
    **2.4**Accretion
      charges recorded in depreciation expense
    
    
    0.2Revisions
      made to the original estimated cash flows
    
    
    (0.4
    )**December
      31, 2004**
    
    
    **2.2**




**9.**
    **CAPITAL
      STOCK**


****


**Common
Shares**





The
Company is authorized to issue an unlimited number of the common shares. The
holders of the common shares are entitled to one vote for each share held at any
meeting of shareholders of the Company. The common shares are convertible, at
the option of the common shareholders at any time into class B non-voting shares
on a share-for-share basis. The common shares may be subject to constraints on
transfer to ensure the Company’s compliance with the foreign ownership
provisions of the *Telecommunications
Act (Canada).* The
common shares rank *pari
passu* with
the class B non-voting shares on a per share basis with respect to the payment
of dividends and the right to participate in a distribution of assets of the
Company on winding up, dissolution or otherwise.





**Class
B Non-Voting Shares**





The
Company is authorized to issue an unlimited number of the class B non-voting
shares. The holders of the class B non-voting shares are not entitled to vote at
any meeting of shareholders of the Company except for votes affecting class B
non-voting shares. The class B non-voting shares are convertible, at the option
of the class B shareholders, at any time into common shares on a share-for-share
basis, in certain circumstances. The class B non-voting shares rank *pari
passu* with
the common shares on a per share basis with respect to the payment of dividends
and the right to participate in a distribution of assets of the Company on
winding up, dissolution or otherwise.





**Preferred
Shares**





The
Company is authorized to issue an unlimited number of the preferred shares,
although no preferred shares were issued in connection with the Plan of
Arrangement. However, as part of the consideration for entering into a
commercial agreement with the Company *[note
11]* ,
Sprint was issued one preferred share





16




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


(for a
value of one dollar) and is the only holder of preferred shares. There were no
other preferred shares outstanding at December 31, 2004. The preferred shares
are generally non-voting and have no right to dividends. Preferred shares
entitle the holder to nominate and elect two directors of the Company. The
preferred shares also have a priority right over all other classes of shares to
receive a return of capital equal to one dollar per preferred share upon the
liquidation, dissolution or winding up of the Company.





The
following tables detail the changes in capital stock for the years ended
December 31, 2004 and 2003, and the nine months ended December 31,
2002:




**Number
      of Shares**
    
    **Common**
    
    **Class
      B**
    
    **Preferred****Balance,
      April 1, 2002**
    
    
    **3,686,833**
    
    
    **20,152,805**
    
    
    **1**Converted
      during the nine months ended December 31, 2002
    
    
    364,394
    
    
    (364,394
    )
    
    **-****Balance,
      December 31, 2002**
    
    
    **4,051,227**
    
    
    **19,788,411**
    
    
    **1**Issued
      during the year
    
    
    -
    
    
    11,500,000
    
    
    **-**Issued
      pursuant to restricted stock units
    
    
    239,499
    
    
    -
    
    
    **-**Issued
      pursuant to stock options
    
    
    883
    
    
    -
    
    
    **-**Converted
      during the year, net
    
    
    (80,751
    )
    
    80,751
    
    
    **-**Fractional
      shares eliminated due to conversions during the year
    
    
    (19
    )
    
    (10
    )
    
    **-****Balance,
      December 31, 2003**
    
    
    **4,210,839**
    
    
    **31,369,152**
    
    
    **1**Issued
      pursuant to restricted stock units
    
    
    173,000
    
    
    -
    
    
    -Issued pursuant to stock options
    
    
    11,015
    
    
    -
    
    
    -Converted
      during the year, net
    
    
    (92,873
    )
    
    92,873
    
    
    -Fractional
      shares eliminated due to conversions during the year
    
    
    30
    
    
    -
    
    
    -**Balance,
      December 31, 2004**
    
    
    **4,302,011**
    
    
    **31,462,025**
    
    
    **1**


**Dollars**
    
    **Common**
    
    **Class
      B**
    
    **Preferred****Balance,
      April 1, 2002**
    
    
    **45.8**
    
    
    **260.5**
    
    
    **-**Converted
      during the nine months ended December 31, 2002
    
    
    4.5
    
    
    (4.5
    )
    
    **-****Balance,
      December 31, 2002**
    
    
    **50.3**
    
    
    **256.0**
    
    
    **-**Issued
      during the year
    
    
    -
    
    
    40.6
    
    
    **-**Issued
      pursuant to restricted stock units
    
    
    0.5
    
    
    -
    
    
    **-**Converted
      during the year, net
    
    
    (1.0
    )
    
    1.0
    
    
    **-****Balance,
      December 31, 2003**
    
    
    **49.8**
    
    
    **297.6**
    
    
    **-**Issued
      pursuant to restricted stock units
    
    
    0.7
    
    
    -
    
    
    **-**Stock
      options exercised
    
    
    0.1
    
    
    -
    
    
    **-**Converted
      during the year, net
    
    
    (0.9
    )
    
    0.9
    
    
    **-****Balance,
      December 31, 2004**
    
    
    **49.7**
    
    
    **298.5**
    
    
    **-**





During
2003, the Company issued 11,500,000 class B non-voting shares at a price of
$3.75 per share. Net proceeds to the Company after deducting fees and expenses
were $40.6.





**Contributed
Surplus**





The
following table details the changes in contributed surplus for the years ended
December 31, 2004 and 2003, and the nine months ended December 31,
2002:





17




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


**Contributed
      Surplus**
    
    **Dollars****Balance,
      April 1, 2002**
    
    **-**Stock-based
      compensation expense for the nine months ended December 31,
      2002
    
    1.2**Balance,
      December 31, 2002**
    
    
    **1.2**Stock-based
      compensation expense for the year
    
    
    1.7**Balance,
      December 31, 2003**
    
    
    **2.9**Stock-based
      compensation expense for the year
    
    
    1.5**Balance,
      December 31, 2004**
    
    
    **4.4**


****


**Stock
Options**





Under the Option
Plan, the Company currently has reserved a total maximum of 2,261,000 common and
class B non-voting shares. Options granted under the Option Plan will be
non-assignable and will expire no more than 10 years from their date of grant or
as determined by the board of directors. The number of common shares and class B
non-voting shares reserved for issuance in the aggregate to any one eligible
person pursuant to the Option Plan shall not exceed five per cent of the
aggregate outstanding common shares and class B non-voting shares. All shares
reserved for issuance under the Option Plan are granted under the terms and
conditions of the Plan of Arrangement. The Option Plan permits the granting or
repricing of options at a price no less than the closing price of the applicable
shares on the Toronto Stock Exchange on the business day preceding the date on
which the option is granted, or re-priced, as the case may be. Vesting of the
options occurs in three yearly installments of 33.3 per cent each. Vesting of
those options carrying an exercise price of $8.50 is also dependent on the stock
price reaching certain performance levels.





The following is a
continuity of stock options outstanding for which common shares have been
reserved:





**Common
      Shares****Weighted-****Average****Number**
    
    **Exercise
      Price****Outstanding**
    
    **Per
      Share****Balance,
      April 1, 2002**
    
    
    **-**
    
    
    **-**Granted
      during the nine months ended December 31, 2002
    
    
    **1,016,150**
    
    
    **8.27**Cancelled
      during the nine months ended December 31, 2002
    
    
    (89,900
    )
    
    8.50**Balance,
      December 31, 2002**
    
    
    **926,250**
    
    
    **8.25**Granted
      during the year
    
    
    517,500
    
    
    2.42Exercised
      during the year
    
    
    (883
    )
    
    0.65Cancelled
      during the year
    
    
    (86,800
    )
    
    6.99**Balance,
      December 31, 2003**
    
    
    **1,356,067**
    
    
    **6.11**Granted
      during the year
    
    
    488,800
    
    
    4.50Exercised
      during the year
    
    
    (11,015
    )
    
    1.71Cancelled
      during the year
    
    
    (173,868
    )
    
    6.16**Balance,
      December 31, 2004**
    
    
    **1,659,984**
    
    
    **5.66****Exercisable,
      December 31, 2004**
    
    
    **161,347**
    
    
    **2.21**








18




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


The following table
summarizes information about the common shares stock options outstanding at December 31,
2004:




**Common
Shares**


**Options
      Outstanding**
    
    **Options
      Exercisable****Weighted
      -****Average**
    
    **Weighted
      -**
    
    
    
    **Weighted
      -****Number**
    
    **Remaining**
    
    **Average**
    
    **Number**
    
    **Average****Outstanding**
    
    **Contractual**
    
    **Exercise**
    
    **Exercisable**
    
    **Exercise****Range
      of**
    
    **at
      Dec 31,**
    
    **Life
      in**
    
    **Price**
    
    **at
      Dec 31,**
    
    **Price**
    
    **Expiry****Exercise
      Prices**
    
    **2004**
    
    **Years**
    
    **Per
      Share**
    
    **2004**
    
    **Per
      Share**
    
    **Dates**$0.65 to
      $0.80
    
    
    28,184
    
    
    4.6
    
    $
    0.66
    
    
    18,195
    
    $
    0.66
    
    
    2009$1.80
    
    
    331,100
    
    
    5.2
    
    $
    1.80
    
    
    109,554
    
    $
    1.80
    
    
    2010$2.34
    
    
    12,000
    
    
    6.8
    
    $
    2.34
    
    
    -
    
    
    -
    
    
    2011$2.64
    
    
    5,600
    
    
    6.8
    
    $
    2.64
    
    
    -
    
    
    -
    
    
    2011$3.90
    
    
    11,200
    
    
    6.6
    
    $
    3.90
    
    
    -
    
    
    -
    
    
    2011$4.02
    
    
    5,000
    
    
    6.3
    
    $
    4.02
    
    
    -
    
    
    -
    
    
    2011$4.35
    
    
    94,000
    
    
    5.6
    
    $
    4.35
    
    
    31,332
    
    $
    4.35
    
    
    2010$4.60
    
    
    432,000
    
    
    6.2
    
    $
    4.60
    
    
    -
    
    
    -
    
    
    2011$5.15
    
    
    6,800
    
    
    5.8
    
    $
    5.15
    
    
    2,266
    
    $
    5.15
    
    
    2010$8.50
    
    
    734,100
    
    
    4.3
    
    $
    8.50
    
    
    -
    
    
    -
    
    
    2009





During the year
ended December 31, 2004, there were no stock options granted for which class B
non-voting shares have been reserved. As at December 31, 2004, there were no
class B non-voting shares stock options outstanding.





The
weighted-average fair value for options granted during the year ended December
31, 2004 is $2.87 [2003 - $1.61, nine month period ended December 31, 2002 -
$5.60]. The fair value of each option granted was estimated on the date of grant
using the Black-Scholes option pricing model with the following
assumptions:





**2004**
    
    2003
    
    2002Risk
      free interest rate
    
    
    **2.23**
    **%**
    
    3.35
    %
    
    5.41
    %Expected
      dividend yield
    
    
    **0**
    **%**
    
    0
    %
    
    0
    %Expected
      volatility, common shares
    
    
    **102.9**
    **%**
    
    107.9
    %
    
    65.6
    %Expected
      time until exercise, in years
    
    
    **3.0**
    
    
    3.0
    
    
    6.9





The total
compensation cost recognized for the year related to stock options is $1.5 [2003
- $1.7, 2002 - $1.2]. The amounts transferred from contributed surplus to share
capital are negligible in 2004 and 2003.





**Shareholders’
Rights Plan**





The
Rights Plan was adopted to ensure that if a person or group is seeking to
acquire beneficial ownership of 20 per cent or more of the common shares, or 20
per cent of the aggregate shares of the Company, the shareholders and the board
of directors are given sufficient time to evaluate the transaction, negotiate
with the proposed acquirer, encourage competing bids to emerge, and ensure that
all alternatives to the transaction designed to maximize shareholder value have
been considered. The term of the Rights Plan is until the termination of the
Company’s 2007 annual shareholders meeting. Under the Rights Plan, one right was
issued in respect of each share outstanding immediately following the





19





**Call-Net
Enterprises Inc.**

**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**

Year
ended December 31, 2004
[millions
of Canadian dollars, unless otherwise indicated]





implementation
of the Plan of Arrangement. In addition, one right will be issued in respect of
each new share issued thereafter. When exercisable, each right will permit the
holder to purchase shares with a market value of 200 dollars on payment of 100
dollars.





**Restricted
Stock Unit Plan**





Restricted
Stock Units [RSUs] are subject to vesting provisions, which may include, at the
discretion of the board of directors, the achievement of performance criteria.
RSU grants are settled by the delivery of shares to the participant or, at the
participant’s option, the delivery of the cash equivalent market value of the
shares based on the five trading day average of the closing price of the common
shares on the Toronto Stock Exchange [‘TSX’]. If shares are to be delivered, the
Company will have the option to deliver shares issued from treasury or shares
purchased on the TSX by an independent administrator. The RSUP provides that the
maximum number of shares deliverable to participants under the RSUP shall be
678,000 shares. The maximum term for any RSU is three years. The outstanding
RSUs vest in three annual installments of 33.3 per cent each. The resulting
compensation expense recorded for the year ended December 31, 2004 is
insignificant [2003 - $1.6, nine months ended December 31, 2002 - $0.2, three
months ended March 31, 2002 - nil].





The
following is a continuity of RSUs outstanding for which common shares have been
reserved:




**Restricted
Stock Units**


**Number
      Outstanding****Balance,
      April 1, 2002**
    
    
    **-**Granted
      during the nine months ended December 31, 2002
    
    
    652,000Cancelled
      during the nine months ended December 31, 2002
    
    
    (66,500
    )**Balance,
      December 31, 2002**
    
    
    **585,500**Settled
      during the year
    
    
    (239,499
    )**Balance,
      December 31, 2003**
    
    
    **346,001**Settled
      during the year
    
    
    (173,000
    )Cancelled
      during the year
    
    
    (8,000
    )**Balance,
      December 31, 2004**
    
    
    **165,001**





**Deferred
Share Unit Plan**





Participants
of the DSUP can elect to receive a portion of their annual compensation in the
form of Deferred Share Units [‘DSUs’]. The number of DSUs received is calculated
using the amount of compensation directed to the plan, divided by the share
price, based on the five trading day average of the closing price of the common
shares or class B non-voting shares as applicable on the TSX. DSUs are
redeemable upon the departure of the participant from the Company by the
delivery of common shares or class B non-voting shares as applicable, equal to
the number of DSUs credited to the participant, or at the participant’s option,
the delivery of cash equal to the number of DSUs credited to the participant’s
account multiplied by the five day trading average of the closing price of the
applicable shares on the TSX on the date of termination. If shares are to be
delivered, the shares will be purchased on the TSX by an independent
administrator. The resulting additional compensation expense recorded during the
year ended December 31, 2004 is $0.2 [2003, nine months ended December 31, 2002
and three months ended March 31, 2002 - nil].








20




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


The
following is a continuity of the DSUs outstanding for which common shares have
been reserved:




**Deferred
Share Units**


**Number
      Outstanding****Balance,
      April 1 and December 31, 2002**
    
    
    **-**Granted
      during the year
    
    
    8,892Settled
      during the year
    
    
    (1,694
    )**Balance,
      December 31, 2003**
    
    
    **7,198**Granted
      during the year
    
    
    53,970**Balance,
      December 31, 2004**
    
    
    **61,168**





**Pre-recapitalization
Common Shares**





The
Company was authorized to issue an unlimited number of common shares. The
holders of common shares were entitled to one vote for each share held at any
meeting of shareholders of the Company. The common shares were subject to
constraints on transfer to ensure the Company’s compliance with the foreign
ownership provisions of the *Telecommunications
Act (Canada).*





**Pre-recapitalization
Preferred Shares**





The
Company was authorized to issue in series an unlimited number of preferred
shares of which none were outstanding at December 31, 2002 and 2001. The board
of directors determined the rights and attributes when each series was
issued.





**Pre-recapitalization
Class B Non-Voting Shares**





The
class B non-voting shares were created in October 1993 when each common share
then outstanding was converted into one common share and one class B non-voting
share.





The
class B non-voting shares ranked *pari
passu* with
the common shares and class C non-voting shares on a per share basis with
respect to the payment of dividends and the right to participate in a
distribution of assets of the Company on winding up, dissolution or otherwise.
The holders of class B non-voting shares were not entitled to vote at any
meeting of shareholders of the Company.





**Pre-recapitalization
Class C Non-Voting Shares**





The
class C non-voting shares could not be held by parties other than Sprint, its
affiliates and permitted associates. The class C non-voting shares ranked *pari
passu* with
common shares and class B non-voting shares on a per share basis with respect to
the payment of dividends and the right to participate in a distribution of
assets of the Company on winding up, dissolution or otherwise. The holders of
class C non-voting shares were not entitled to vote at any meeting of
shareholders of the Company. However, the holders of the class C non-voting
shares were entitled to elect up to three directors of the Company as long as
they maintained a significant equity interest in the Company.





The
class C non-voting shares could be converted into class B non-voting shares (on
a share-for-share basis) at any time or common shares and class B non-voting
shares (on the basis of one-half common share and one-half class B non-voting
share for each class C non-voting share) in certain circumstances.





21





**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


**Number
      of Pre-recapitalization Shares**
    
    **Common**
    
    **Class
      B**
    
    **Class
      C****Balance,
      December 31, 2000 and 2001**
    
    
    17,580,396
    
    
    51,093,362
    
    
    21,775,017Issued
      pursuant to options
    
    
    -
    
    
    142,218
    
    
    -Cancelled
      pursuant to Plan of Arrangement*[note
      1]*
    
    
    (17,580,396
    )
    
    (51,235,580
    )
    
    (21,775,017
    )**Balance,
      December 31, 2002**
    
    
    **-**
    
    
    **-**
    
    
    **-**





**Dollars,
      pre-recapitalization**
    
    **Common**
    
    **Class
      B**
    
    **Class
      C****Balance,
      December 31, 2000 and 2001**
    
    
    124.8
    
    
    863.5
    
    
    347.8Issued
      pursuant to options
    
    
    -
    
    
    -
    
    
    -Cancelled
      pursuant to Plan of Arrangement*[note
      1]*
    
    
    (124.8
    )
    
    (863.5
    )
    
    (347.8
    )**Balance,
      December 31, 2002**
    
    
    **-**
    
    
    **-**
    
    
    **-**





***2002
Transactions***





All
pre-recapitalization common shares, pre-recapitalization class B non-voting
shares and pre-recapitalization class C non-voting shares were cancelled
pursuant to the Plan of Arrangement *[note
1].*


**10.**
    **INCOME
      TAXES**





The
reconciliation of income tax computed at the statutory tax rates to the
provision for income taxes is as follows:





Pre-recapitalizationNine
    
    ThreeMonths
    
    MonthsEnded
    
    EndedDec
      31,
    
    Mar
      31,**2004**
    
    2003
    
    2002
    
    2002Income
      tax recovery based on the combined statutory rate of 36% [2003 - 37%; 2002
      - 39%]
    
    
    **26.0**
    
    
    11.5
    
    
    22.1
    
    
    36.2Tax
      effect of items not taxable (deductible) for tax
    
    
    **(6.8**
    **)**
    
    8.8
    
    
    34.6
    
    
    (3.7
    )Unrecognized
      tax benefits of losses and temporary differences
    
    
    **(19.2**
    **)**
    
    (20.3
    )
    
    (56.7
    )
    
    (35.8
    )Realization
      of income tax assets not recognized on implementation of fresh start
      accounting
    
    
    **(3.9**
    **)**
    
    (4.3
    )
    
    -
    
    
    -Large
      corporations tax
    
    
    **(2.4**
    **)**
    
    (2.0
    )
    
    (2.6
    )
    
    1.0Reduction
      in future income tax liability resulting from substantively enacted tax
      rate reduction
    
    
    **-**
    
    
    -
    
    
    -
    
    
    3.3Income
      taxes benefit (expense)
    
    
    **(6.3**
    **)**
    
    (6.3
    )
    
    (2.6
    )
    
    1.0





Upon
the implementation of the Plan of Arrangement and the application of fresh start
accounting, a full valuation was recorded against the pre-recapitalization
future income tax assets of the Company. If any tax benefits from this future
income tax asset are subsequently realized, the benefit is recorded first as a





22





**Call-Net
Enterprises Inc.**

**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**

Year
ended December 31, 2004
[millions
of Canadian dollars, unless otherwise indicated]


reduction
of the intangible assets recorded upon the application of fresh start accounting
and, if these assets are fully drawn down, as a capital transaction within
contributed surplus. During the year ended December 31, 2004 and 2003, the
Company utilized tax benefits that arose prior to fresh start accounting
totaling $3.9 and $4.3, respectively, which has been recorded as a reduction to
unamortized customer relationships *[note
6]* .





Future
income tax benefit consists of tax (benefits) liabilities arising
from:





**2004**
    
    2003Benefits:Taxable
      loss carryforwards
    
    
    **(408.1**
    **)**
    
    (383.8
    )Tax
      values of capital assets in excess of accounting values
    
    
    **(27.5**
    **)**
    
    (41.7
    )Tax
      values of other assets in excess of accounting values
    
    
    **(8.9**
    **)**
    
    (11.5
    )Accounting
      values of liabilities in excess of tax values
    
    
    **(4.2******
    **)******
    
    (3.7
    )Total
      future tax benefit
    
    
    **(448.7**
    **)**
    
    (440.7
    )Liabilities:Accounting
      values of capital assets in excess of tax values
    
    
    **7.4**
    
    
    21.5Tax
      values of liabilities in excess of accounting values
    
    
    **14.0**
    
    
    23.1Total
      future income tax liability
    
    
    **21.4**
    
    
    44.6Net
      future income tax benefit
    
    
    **(427.3**
    **)**
    
    (396.1
    )Valuation
      allowance
    
    
    **427.3**
    
    
    396.1Net
      future income tax benefit
    
    
    **-**
    
    
    -





At
December 31, 2004, the Company had approximately $1,031.8 in losses available
for Canadian income tax purposes to reduce future years' taxable income. Of
these losses, $878.6 relate to losses which arose prior to the application of
fresh start accounting. Income tax losses will expire as follows:





2006
    
    
    **208.4**2007
    
    
    **289.5**2008
    
    
    **222.0**2009
    
    
    **234.6**2010
    
    
    **42.6**2014
    
    
    **34.7****1,031.8**





At
December 31, 2004, the Company had approximately $111.0 in losses available for
U.S. income tax purposes to reduce future years' taxable income. Income tax
losses will expire as follows:





2021
    
    
    **8.6**2022
    
    
    **72.6**2023
    
    
    **10.2**2024
    
    
    **19.6****111.0**








23




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]





**11.**
    **COMMITMENTS
      AND GUARANTEES**





The
Company leases office space under operating leases that expire through 2013. The
Company also has agreements with certain telephone companies that guarantee the
long-term supply of network facilities and agreements relating to the operations
and maintenance of the network. In addition, the Company enters into agreements
with suppliers to provide services and products that include minimum spend
commitments.





The
future minimum payments under these agreements in aggregate and for each of the
next five years and thereafter are as follows:





**Office**
    
    **Network**
    
    **Other
      Services****Space**
    
    **Facilities**
    
    &
      Products2005
    
    
    14.3
    
    
    21.2
    
    
    37.22006
    
    
    13.8
    
    
    17.2
    
    
    27.92007
    
    
    5.2
    
    
    9.7
    
    
    10.52008
    
    
    2.9
    
    
    8.7
    
    
    8.92009
    
    
    2.2
    
    
    5.6
    
    
    5.9Thereafter
    
    
    3.5
    
    
    0.2
    
    
    35.441.9
    
    
    62.6
    
    
    125.8





On
November 20, 2004, the Company entered an agreement with Bell Canada to obtain
certain operating and network services *[note
13].*





On
April 10, 2002, the Company and Sprint executed an agreement [the ’Sprint
Agreement’] that was contingent upon the approval and completion of the Plan of
Arrangement. The term of the Sprint Agreement is for a period of 10 years
commencing April 1, 2002. The Sprint Agreement requires Sprint or its affiliates
to provide various products and services to the Company. In addition, the
Company continues to have exclusive use of the Sprint trademark in Canada for
these services. The Company and Sprint have agreed to treat each other with
‘preferred partner’ status. In connection with the granting of the technology
license and the trademark license, the Company will pay a 2.5 per cent royalty
to Sprint on substantially all revenue for the first five years and 2.0 per cent
for the remaining five years of the term.





Periodically
in the normal course of conducting its business, the Company enters into various
dispositions of its excess fibre, land interests, switch equipment and other
related assets. The terms of these agreements generally include representations
and warranties concerning the assets being sold. As well, indemnities for breach
of these representations and warranties may be provided to the purchaser,
usually limited to the value of the particular transaction. Historically these
payments have not been significant.





A
review of the major dispositions of the Company and its predecessors has been
conducted to establish a summary of the outstanding indemnities. Terms of
agreements generally provide for a limitation of losses and to the best of its
knowledge the Company considers the exposure under the indemnities it has
provided are unlikely to result in claims representing a material
amount.





Occasionally, in
the normal course of business the Company provides guarantees of third party
performance in respect of customer lease arrangements. As at December 31, 2004,
the total of these obligations is $nil [2003 - $0.6].





24





**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


**12.**
    **CONTINGENCIES**





**Litigation**





On March 1, 2002,
the Company was notified of an appeal of the Superior Court of Ontario decision
with respect to an application brought by Montreal Trust Company of Canada (now
Computershare Investor Services Inc.) on April 27, 2000 concerning the payment
of $30.0 held in trust under a ‘change in control agreement’ with certain senior
management dated September 9, 1999. The Superior Court of Ontario ruled that no
change of control had occurred. On February 20, 2004, the Court of Appeal of
Ontario agreed with the trial judge and dismissed the appeal of an earlier
decision regarding a ‘change in control agreement’. As at April 20, 2004, the
60-day period in which the appellants had to seek leave to appeal to the Supreme
Court of Canada expired. The Company reversed a $4.7 provision related to this
action during 2004.





In the ordinary
course of business activities, the Company may be contingently liable for
litigation and claims with customers, suppliers and former employees. Management
believes that adequate provisions have been recorded in the accounts where
required. Although it is not possible to estimate the potential costs and
losses, if any, management believes that the ultimate resolution of such
contingencies will not have a material adverse effect on the consolidated
financial position of the Company.





**13.**
    **ACQUISITIONS**





Effective
November 20, 2004, the Company acquired significant portions of 360networks
Corporation’s business customer base in Ontario, Quebec and Atlantic Canada,
from Bell Canada. The acquisition price for the business customer relationships
is measured based on three times the average revenue of the acquired customer
base in the two months pre- and post the closing date of the transaction, and
will be paid over a two-year period. Taking acquisition costs into account, the
total cost for the customer relationships intangible asset is $17.6. This is a
preliminary estimate and is subject to adjustment in the first quarter of fiscal
2005. At December 31, 2004, $7.1 of the customer relationship liability was
included within accrued liabilities and $10.0 was included in other long-term
liabilities *[note
8(b)].*





Concurrently,
the Company entered into a two-year transitional services agreement under which
Bell Canada will provide technical and operational services to the newly
acquired customer base and in exchange be paid approximately 70 per cent of the
total retail revenue with a minimum monthly payment of approximately $2.0. The
Company also has entered into an option agreement under which the Company has
four months to determine which assets used to service the acquired customers it
may wish to acquire from Bell Canada at the end of the transitional services
agreement. As consideration for the option, the Company will pay up to $2.3, or
7.5 per cent of the expected $30.0 maximum price payable, for the assets in the
second quarter of fiscal 2005.





On July
15, 2003, the Company acquired the business of MPS Canada, a reseller of private
label long distance services, from its parent company Mosaic Group Inc. The
assets acquired include working capital valued at $3.3, computer equipment,
software, furniture and fixture assets valued at $2.7 and customer relationships
valued at $13.7. This acquisition was accounted for as a business acquisition
using the purchase method, and the results of operations were included in these
consolidated financial statements from the date of acquisition. The purchase
price was allocated to net identifiable assets acquired based on their estimated
fair values. This business operates as eForce, a division of a subsidiary of the
Company.








25





**Call-Net
Enterprises Inc.**

**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**

Year
ended December 31, 2004
[millions
of Canadian dollars, unless otherwise indicated]


On
September 27, 2002, the Company acquired 75 per cent of the non-voting shares
and 24 per cent of the voting shares in Time iCR Inc., a provider of customized,
managed and hosted call processing solutions, for $1.0. The assets and
liabilities acquired were less than $2.6 and $2.6, respectively. The Company
also had a call right under a contractual arrangement with a member of Time
iCR’s management who owns 51 per cent of the outstanding voting rights of Time
iCR Inc. As a result, while the Company did not have voting control of Time iCR
Inc., the Company determined under generally accepted accounting principles it
would consolidate its interest in Time iCR Inc. On February 13, 2004 the Company
acquired the remaining 25 per cent non-voting shares and 76 per cent voting
shares of Time iCR for $0.4. This acquisition has been accounted for as a
business acquisition using the purchase method, and the results of operations
were included in these consolidated financial statements from the dates of
acquisition. The purchase price was allocated to the net identifiable assets
acquired based on their estimated fair values.





**14.**
    **RELATED
      PARTY TRANSACTIONS**





In the
normal course of business, for each of the periods in the three years ended
December 31, the Company has engaged in significant sales and purchases of
telecommunication services with Sprint Corporation, which maintains an
approximate 6.6 per cent equity interest in the Company, through its subsidiary,
Sprint. These transactions were made at market prices under normal trade terms
and conditions. In addition, a royalty payment based on revenues is paid to
Sprint *[note
11]* which
is included within the consolidated statements of operations and deficit. At
December 31, 2004, the net balance due to Sprint and its affiliates is $12.3
[2003 - $12.9]. Revenue, carrier charges and royalty costs transactions with
Sprint and its affiliates for each of the periods in the three years ended
December 31 are as follows:







Pre-recapital-izationNine
    
    ThreeMonths
    
    MonthsEnded
    
    EndedDec
      31,
    
    Mar
      31,**2004**
    
    2003
    
    2002
    
    2002Revenue
    
    
    **30.4**
    
    
    27.0
    
    
    14.9
    
    
    5.5Carrier
      charges
    
    
    **42.4**
    
    
    44.0
    
    
    33.7
    
    
    11.4Royalty
      costs
    
    
    **19.7**
    
    
    19.5
    
    
    19.5
    
    
    -





In the normal
course of business, for each of the periods in the three years ended December
31, the Company has engaged in sales of telecommunication services with a
related entity, in which the Company maintains an approximate 7.5 per cent
equity interest and has a right to appoint two positions on its board. These
transactions were made at market prices under normal trade terms and conditions.
Revenue derived from this entity were $3.5 [2003 - $3.2; nine months ended
December 31, 2002 - $1.8; three months ended March 31, 2002 - $0.6].





In the normal
course of business, for each of the periods in the three years ended December
31, the Company has engaged in sales of telecommunication services with
companies to which various members of the Company’s board of directors are
related. These transactions were made at market prices under normal trade terms
and conditions and total less than $1.5 in each of the periods presented.





26





**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


**15.**
    **REALIGNMENT,
      RESTRUCTURING AND OTHER CHARGES**




Pre-recapital-izationNine
    
    ThreeMonths
    
    MonthsEnded
    
    EndedDec
      31,
    
    Mar
      31,**2004**
    
    2003
    
    2002
    
    2002Realignment
      charge (a)
    
    
    **7.8**
    
    
    -
    
    
    -
    
    
    **-**Non-recoverable
      fibre maintenance costs (b)
    
    
    **(6.6**
    **)**
    
    7.0
    
    
    -
    
    
    **-**Special
      charge (c)
    
    
    **-**
    
    
    -
    
    
    30.5
    
    
    **-****1.2**
    
    
    7.0
    
    
    30.5
    
    
    **-**





(a)
    In
      2004, the Company recorded a special charge of $7.8 for severance incurred
      as part of its plan to improve organizational effectiveness by
      consolidating its corporate, operations, marketing and provisioning
      functions and eliminating two executive positions. The details of the
      movement in the severance provision during the year is shown
      below.





**Severance
      Provision****Balance,
      December 31, 2003**
    
    
    **-**Special
      charges recorded during the year
    
    
    7.8Payments
      made during the year
    
    
    (2.6
    )**Balance,
      December 31, 2004**
    
    **$**
    **5.2**





As at
      December 31, 2004, $5.2 of this provision was included in accounts payable
      and accrued liabilities and is expected to be paid by March 31, 2005.(b)
    During
      2003, the Company recorded a special charge of $7.0 for fibre maintenance
      costs that were expected to be incurred by the Company under contracts for
      up to 15 years in length without any foreseeable future economic benefit
      and for which the Company had determined there is no reasonable prospect
      of recovery.  During 2004, the Company reversed $6.6 of this charge
      since an agreement was reached under which it abandoned both the fibre and
      the commitment. As at December 31, 2004, none of this charge remained in
      the Company’s liabilities.(c)
    In
      2002, the Company recorded a special charge of $19.8 for severance,
      facility, lease and contract termination costs incurred as part of its
      plan to further streamline and focus on its operations. As well, during
      this period the Company recorded a special charge of $10.7 for a provision
      on redundant assets.All
      amounts except for the facility lease exit costs were drawn down by the
      end of 2003. The details of the movement in the lease exit provision
      during the year is shown below. The remaining balance will be paid over
      the terms of the related leases up to a maximum period of seven
      years.





27




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]





**Lease
      Exit Costs****Balance,
      April 1, 2002**
    
    **$**
    **7.2**Payments
      made during the nine months ended December 31, 2002
    
    
    (0.4
    )**Balance,
      December 31, 2002**
    
    **$**
    **6.8**Payments
      made during the year
    
    
    (2.1
    )**Balance,
      December 31, 2003**
    
    **$**
    **4.7**Payments
      made during the year
    
    
    (0.9
    )**Balance,
      December 31, 2004**
    
    **$**
    **3.8**





As
      at December 31, 2004 and 2003, the current portion of $1.0 and $1.0,
      respectively, of the lease exit cost liability was included within accrued
      liabilities and $2.8 and $3.7 was included in other long-term liabilities,
      respectively*[note
      8(b)].***16.**
    **EARNINGS
      (LOSS) PER SHARE**





Earnings
(loss) per share have been calculated on the basis of income (loss) divided by
the weighted average number of common shares and class B ****** non-voting
shares outstanding during the period after recapitalization [December 31, 2004 -
35,713,781; December 31, 2003 - 27,484,447; December 31, 2002 - 23,839,638].
Earnings (loss) per share for three months ended March 31, 2002 have been
calculated on the basis of income (loss) divided by the weighted-average number
of pre-recapitalization common shares, pre-recapitalization class B ****** non-voting
shares and pre-recapitalization class C non-voting shares outstanding during the
year. The pre-recapitalization weighted-average number of shares outstanding has
been restated to give effect to the 1:20 stock consolidation which occurred
April 15, 2002 [March 31, 2002 - 4,529,550]. Due to a loss for all periods
presented, no incremental shares from the potential exercise of stock options
are included because the effect would be anti-dilutive. As at December 31, 2004,
2003 and 2002, the Company had 1,659,984, 1,356,067 and 926,250 stock options
outstanding, which could be dilutive to future periods. For these same periods,
it had 165,001, 346,001 and 585,500 RSUs and 61,168, 7,198 and nil DSUs which
could be dilutive to future periods.




**17.**
    **CONSOLIDATED
      STATEMENTS OF CASH FLOWS**





**Net
Change in Non-Cash Working Capital Balances**





Pre-recapitali-zationNine
    
    ThreeMonths
    
    MonthsEnded
    
    EndedDec
      31,
    
    Mar
      31,****
    
    **2004**
    
    2003
    
    2002
    
    2002Accounts
      receivable
    
    
    **19.9**
    
    
    47.8
    
    
    24.0
    
    
    23.1Other
      current assets
    
    
    **18.9**
    
    
    (43.3
    )
    
    40.7
    
    
    1.0Accounts
      payable and accrued liabilities
    
    
    **(10.4**
    **)**
    
    (2.0
    )
    
    (4.4
    )
    
    (32.4
    )**Net
      change in non-cash working capital balances related to
      operations**
    
    
    **28.4**
    
    
    2.5
    
    
    60.3
    
    
    (8.3
    )








28




**Call-Net
Enterprises Inc.**





**NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**





Year
ended December 31, 2004


[millions
of Canadian dollars, unless otherwise indicated]


****


**Non-Cash
Transactions**





Acquisition of
capital assets as shown in the consolidated statements of cash flows and changes
in accounts payable and accrued liabilities were increased (reduced) by accrued
amounts as follows:





Pre-recapital-izationNine
    
    ThreeMonths
    
    MonthsEnded
    
    EndedDec
      31,
    
    Mar
      31,****
    
    **2004**
    
    2003
    
    2002
    
    2002Accrued
      amounts
    
    
    **(1.6**
    **)**
    
    (2.2
    )
    
    8.2
    
    
    (3.8
    )





During 2003, the
Company entered into an agreement to swap fibre valued at $1.9 in exchange for
consideration of fibre valued at the same amount. Accordingly, this transaction
is not reflected in the consolidated statements of cash flows.





During 2002, the
Company acquired capital assets of $13.2 in exchange for consideration of cash
in trust of $13.2. Accordingly, this transaction is not reflected in the
consolidated statements of cash flows.





**Other
Information**





Pre-recapital-izationNine
    
    ThreeMonths
    
    MonthsEnded
    
    EndedDec
      31,
    
    Mar
      31,****
    
    **2004**
    
    2003
    
    2002
    
    2002Cash
      received for interest
    
    
    **3.9**
    
    
    4.2
    
    
    3.4
    
    
    6.2Cash
      paid for interest
    
    
    **39.0**
    
    
    46.8
    
    
    52.3
    
    
    18.3Cash
      paid for capital and income taxes
    
    
    **5.7**
    
    
    3.4
    
    
    9.9
    
    
    0.5





Commencing in the
fourth quarter of 2004, the Company presents proceeds from sales of accounts
receivable within cash flows from operations on the statement of cash flows.
Previously these had been classified as investing activities. The comparative
figures have been restated to conform to the current year
presentation.





**18.**
    **ADDITIONAL
      FINANCIAL INFORMATION****[a]**
    **Fair
      Values**





The
carrying amounts and estimated fair values of the Company’s financial
instruments as at December 31, 2004 and 2003 are substantially the same, except
as noted below:





29




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


**2004**
    
    2003**Carrying**
    
    **Estimated**
    
    Carrying
    
    Estimated**Amount**
    
    **Fair
      Value**
    
    Amount
    
    Fair
      ValueFinancial
      assets**Investment,
      at cost**
    
    
    0.6
    
    
    0.6
    
    
    **0.4**
    
    
    **0.3**Financial
      liabilities**Long-term
      debt**
    
    
    268.5
    
    
    266.5
    
    
    **387.1**
    
    
    **385.7**





The
fair values of the Company’s financial instruments have been determined as
outlined below. However, the estimated fair values do not necessarily represent
amounts that the Company could potentially realize or be obligated to pay in a
current market exchange between arm’s-length parties.





**Cash
      and cash equivalents, short-term investments, accounts receivable, other
      current assets, accounts payable and accrued
      liabilities**The
      carrying values of the Company’s cash and cash equivalents, short-term
      investments, accounts receivable, other current assets, and accounts
      payable and accrued liabilities approximate fair values due to their
      current nature.**Investment**The
      fair value of the Company’s investment is based on the closing price on
      The Canadian Venture Exchange.**Long-term
      debt**The
      Company’s debt trades over-the-counter and is not listed on an exchange.
      The fair value of the Company’s long-term debt is estimated based on
      current trading values.**Other
      long-term liabilities**The
      fair value of the Company’s other long-term liabilities is based
      predominately on discounted future cash flows and approximates carrying
      value.**[b]**
    **Other
      Disclosures****Credit
      Risk**Short-term
      investments are placed exclusively with entities having ratings of at
      least A-1, A-2, P-1 or P-2 by recognized debt rating
    agencies.The
      Company’s accounts receivable are not subject to any concentration of
      credit risk. The portfolio is diversified as to both geographic and
      industry concentrations.








30




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]





**Currency
      Risk**The Company
      is exposed to risk of currency fluctuation created by the U.S. dollar
      denominated debt obligation, which amounts to U.S.$317.9 that will be paid
      in principal and interest over the remaining term of this
      instrument.  The principal amount of U.S.$223.1 matures on December
      31, 2008.





**19.**
    **SEGMENT
      INFORMATION**





The Company is a
facilities-based carrier of long distance, data, local, enhanced voice and
wireless communications services. It offers different products or services to
three market segments: (i) Consumer Services including residential and small
office and home office customers (ii) Business Services, including small, medium
and large business and government customers and (iii) Carrier Services including
other providers and carriers of telecommunications services.





During the fourth
quarter of 2004, the Company changed the allocation of the Consumer Services
system access fees to allocate to all products based on revenues. Previously,
the Consumer Services system access fees were included in long distance revenue
only. Accordingly, segment information of previous periods has been restated to
reflect this change. Substantially all of the Company’s assets are located in
Canada, and revenues are derived from long distance, data and local
telecommunications services provided in Canada. Assets, including the fibre
optic cable network, are not segmented by business division as assets are shared
by all segments. The Company did not have an economic dependence on any one
customer in 2004 or for all prior periods.





**Customer
Segments**





**Network,****Operations,****Consumer**
    
    **Business**
    
    **Carrier**
    
    **Corporate****Services**
    
    **Services**
    
    **Services**
    
    **and
      other**
    
    **Total****Year
      ended December 31, 2004****Long
      distance**
    
    
    **147.4**
    
    
    **150.9**
    
    
    **129.5**
    
    
    **-**
    
    
    **427.8****Data**
    
    
    **13.1**
    
    
    **142.5**
    
    
    **47.2**
    
    
    **-**
    
    
    **202.8****Local**
    
    
    **124.8**
    
    
    **45.6**
    
    
    **7.3**
    
    
    **-**
    
    
    **177.7****Wireless**
    
    
    **10.3**
    
    
    **-**
    
    
    **-**
    
    
    **-**
    
    
    **10.3****Total
      revenues**
    
    
    **295.6**
    
    
    **339.0**
    
    
    **184.0**
    
    
    **-**
    
    
    **818.6****Operating
      costs**
    
    
    **(119.3**
    **)**
    
    **(78.2**
    **)**
    
    **(9.7**
    **)**
    
    **(105.9**
    **)**
    
    **(313.1**
    **)****176.3**
    
    
    **260.8**
    
    
    **174.3**
    
    
    **(105.9**
    **)**
    
    **505.5****Carrier
      costs**
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    **(400.6**
    **)****Realignment,
      restructuring and other charges**
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    **(1.2**
    **)****Depreciation
      and amortization**
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    **(146.6**
    **)****Operating
      loss**
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    **(42.9**
    **)**











31





**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


Network,Operations,Consumer
    
    Business
    
    Carrier
    
    CorporateServices
    
    Services
    
    Services
    
    and
      other
    
    TotalYear
      ended December 31, 2003Long
      distance
    
    
    165.8
    
    
    153.6
    
    
    162.8
    
    
    -
    
    
    482.2Data
    
    
    17.0
    
    
    134.0
    
    
    50.1
    
    
    -
    
    
    201.1Local
    
    
    84.6
    
    
    31.0
    
    
    4.8
    
    
    -
    
    
    120.4Wireless
    
    
    1.6
    
    
    -
    
    
    -
    
    
    -
    
    
    1.6Total
      revenues
    
    
    269.0
    
    
    318.6
    
    
    217.7
    
    
    -
    
    
    805.3Operating
      costs
    
    
    (98.3
    )
    
    (63.2
    )
    
    (6.9
    )
    
    (130.9
    )
    
    (299.3
    )170.7
    
    
    255.4
    
    
    210.8
    
    
    (130.9
    )
    
    506.0Carrier
      costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (409.9
    )Realignment,
      restructuring and other charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (7.0
    )Depreciation
      and amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (157.3
    )Operating
      loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (68.2
    )








Network,Operations,Consumer
    
    Business
    
    Carrier
    
    CorporateServices
    
    Services
    
    Services
    
    and
      other
    
    TotalNine
      months ended December 31, 2002Long
      distance
    
    
    133.3
    
    
    110.6
    
    
    125.6
    
    
    -
    
    
    369.5Data
    
    
    16.3
    
    
    107.3
    
    
    43.6
    
    
    -
    
    
    167.2Local
    
    
    45.9
    
    
    14.2
    
    
    2.1
    
    
    -
    
    
    62.2Wireless
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Total
      revenues
    
    
    195.5
    
    
    232.1
    
    
    171.3
    
    
    -
    
    
    598.9Operating
      costs
    
    
    (71.3
    )
    
    (43.7
    )
    
    (13.7
    )
    
    (99.8
    )
    
    (228.5
    )124.2
    
    
    188.4
    
    
    157.6
    
    
    (99.8
    )
    
    370.4Carrier
      costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (335.7
    )Realignment,
      restructuring and other charges
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (30.5
    )Depreciation
      and amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (120.7
    )Operating
      loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (116.5
    )








32




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]





Network,Operations,Consumer
    
    Business
    
    Carrier
    
    CorporateServices
    
    Services
    
    Services
    
    and
      other
    
    TotalThree
      months ended March 31, 2002Long
      distance
    
    
    46.4
    
    
    39.7
    
    
    44.6
    
    
    -
    
    
    130.7Data
    
    
    5.9
    
    
    37.6
    
    
    15.4
    
    
    -
    
    
    58.9Local
    
    
    9.4
    
    
    2.5
    
    
    0.3
    
    
    -
    
    
    12.2Wireless
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    -Total
      revenues
    
    
    61.7
    
    
    79.8
    
    
    60.3
    
    
    -
    
    
    201.8Operating
      costs
    
    
    (22.7
    )
    
    (16.7
    )
    
    (2.8
    )
    
    (30.9
    )
    
    (73.1
    )39.0
    
    
    63.1
    
    
    57.5
    
    
    (30.9
    )
    
    128.7Carrier
      costs
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (116.8
    )Depreciation
      and amortization
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (41.8
    )Operating
      loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (29.9
    )





**20.**
    **RECONCILIATION
      TO UNITED STATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES**





These consolidated
financial statements have been prepared in accordance with Canadian GAAP, which
differ in certain respects from U.S. GAAP. The significant adjustments which are
described below would be required in the consolidated financial statements to
comply with U.S. GAAP.





33





**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]





**2004**
    
    2003*Restated**[notes
      2, 7]***Balance
      Sheets - Assets****Canadian
      GAAP - Current Assets**
    
    
    **126.7**
    
    
    241.7Investment
      available for sale (a)
    
    
    **0.6**
    
    
    0.3**U.S.
      GAAP - Current Assets**
    
    
    **127.3**
    
    
    242.0**Canadian
      GAAP - Capital Assets**
    
    
    **458.3**
    
    
    516.7Capitalized
      interest (c)
    
    
    **4.9**
    
    
    5.9Writedowns
      and fresh start adjustments (b)
    
    
    **89.7**
    
    
    89.7Writedown
      of assets held for sale (b)
    
    
    **(78.6**
    **)**
    
    (78.6
    )Depreciation
      of writedowns and fresh start adjustments (b)
    
    
    **(2.0**
    **)**
    
    (3.1
    )Disposal
      of writedowns and fresh start adjustments (b)
    
    
    **(1.7**
    **)**
    
    (1.7
    )Writedown
      of assets (b)
    
    
    **(17.5**
    **)**
    
    -**U.S.
      GAAP - Capital Assets**
    
    
    **453.1**
    
    
    528.9**Canadian
      GAAP - Other Assets**
    
    
    **63.9**
    
    
    80.7Investment
      available for sale (a)
    
    
    **(0.6**
    **)**
    
    (0.4
    )Writedowns
      and fresh start adjustments (b)
    
    
    **8.2**
    
    
    4.3**U.S.
      GAAP - Other Assets**
    
    
    **71.5**
    
    
    84.6**U.S.
      GAAP - Total Assets**
    
    
    **651.9**
    
    
    855.5**Balance
      Sheets - Liabilities****Canadian
      GAAP - Accounts Payable and Accrued Liabilities**
    
    
    **149.7**
    
    
    149.4Disposal
      gain not recognized under fresh start accounting (b)
    
    
    **(0.9**
    **)**
    
    (0.9
    )**U.S.
      GAAP - Accounts Payable and Accrued Liabilities**
    
    
    **148.8**
    
    
    148.5**Canadian
      GAAP - Future Income Tax Liability**
    
    
    **-**
    
    
    -Future
      income tax liability (b)
    
    
    **13.8**
    
    
    21.3**U.S.
      GAAP - Future Income Tax Liability**
    
    
    **13.8**
    
    
    21.3**Canadian
      GAAP - Long-term Debt**
    
    
    **268.5**
    
    
    387.1Future
      interest payments on long-term debt (b)
    
    
    **114.1**
    
    
    205.6**U.S.
      GAAP - Long-term Debt**
    
    
    **382.6**
    
    
    592.7**Canadian
      GAAP - Other long-term Liabilities**
    
    
    **53.3**
    
    
    49.1**U.S.
      GAAP - Other long-term Liabilities**
    
    
    **53.3**
    
    
    49.1**U.S.
      GAAP - Total Liabilities**
    
    
    **598.5**
    
    
    811.6





34





**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


**2004**
    
    2003Restated[note
      2]**Balance
      Sheets - Shareholders’ Equity****Canadian
      GAAP - Capital Stock**
    
    
    **352.6**
    
    
    350.3Share
      purchase incentives
    
    
    **4.6**
    
    
    4.6Reduction
      in stated capital (e)
    
    
    **10.7**
    
    
    10.7Recapitalization
      adjustments (b)
    
    
    **(6.5**
    **)**
    
    (6.5
    )Writedowns
      and fresh start adjustments (b)
    
    
    **1,036.3**
    
    
    1,036.3Issue
      of capital stock (b)
    
    
    **187.9**
    
    
    187.9**U.S.
      GAAP - Capital Stock**
    
    
    **1,585.6**
    
    
    1,583.3**Canadian
      GAAP - Deficit**
    
    
    **(175.2**
    **)**
    
    (96.8
    )Share
      purchase incentives
    
    
    **(4.6**
    **)**
    
    (4.6
    )Reduction
      in stated capital (e)
    
    
    **(10.7**
    **)**
    
    (10.7
    )Writedowns
      and fresh start adjustments (b)
    
    
    **(1,671.8**
    **)**
    
    (1,671.8
    )Reduction
      of intangible assets (b)
    
    
    **8.2**
    
    
    4.3Depreciation
      not recognized under fresh start accounting (b)
    
    
    **(2.0**
    **)**
    
    (3.1
    )Income
      tax benefit related to future tax liability (b)
    
    
    **22.5**
    
    
    14.7Interest
      expense on long-term debt (b)
    
    
    **121.0**
    
    
    88.2Gain
      (loss) on repurchase of long-term debt (b)
    
    
    **133.6**
    
    
    81.9Foreign
      exchange gain on long-term debt (b)
    
    
    **62.2**
    
    
    55.2Loss
      on disposal and write-down of capital assets (b)
    
    
    **(18.3**
    **)**
    
    (0.8
    )Capitalized
      interest (c)
    
    
    **4.9**
    
    
    5.9Change
      in enacted tax rate (d)
    
    
    **(1.9**
    **)**
    
    (1.6
    )**U.S.
      GAAP - Deficit**
    
    
    **(1,532.1**
    **)**
    
    (1,539.2
    )**Canadian
      GAAP - Other Comprehensive Income (Loss)**
    
    
    **-**
    
    
    -Unrealized
      losses on investment available for sale
    
    
    **(0.1**
    **)**
    
    (0.2
    )**U.S.
      GAAP - Other Comprehensive Income (Loss)**
    
    
    **(0.1**
    **)**
    
    (0.2
    )**Total
      U.S. GAAP Shareholders’ Equity (Deficiency)**
    
    
    **53.4**
    
    
    43.9**Total
      U.S. GAAP Liabilities and Shareholders’ Equity
      (Deficiency)**
    
    
    **651.9**
    
    
    855.5








35





**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


****


**Statements
of Operations**





**2004**
    
    2003
    
    2002*Restated*
    
    *Restated**[note
      2]*
    
    *[note
      2]***Net
      income (loss) for the year ended December 31 based on Canadian
      GAAP**
    
    
    **(78.4**
    **)**
    
    (37.5
    )
    
    (151.1
    )Recapitalization
      and fresh start adjustments (b)
    
    
    **-**
    
    
    -
    
    
    (93.8
    )Reduction
      of intangible assets (b)
    
    
    **3.9**
    
    
    4.3
    
    
    -Gain
      on repurchase of long-term debt (b)
    
    
    **51.7**
    
    
    -
    
    
    81.9Interest
      expense on long-term debt (b)
    
    
    **32.8**
    
    
    44.6
    
    
    43.6Foreign
      exchange gain on long-term debt (b)
    
    
    **7.0**
    
    
    51.3
    
    
    3.9Incremental
      loss on disposal and writedown regarding capitalized interest
      (c)
    
    
    **-**
    
    
    (0.2
    )
    
    (4.6
    )Depreciation
      not recognized under fresh start accounting (b)
    
    
    **1.1**
    
    
    (1.5
    )
    
    (1.6
    )Capitalized
      interest, net of depreciation (c)
    
    
    **(1.0**
    **)**
    
    (1.0
    )
    
    (1.0
    )Loss
      on disposal of capital assets (b)
    
    
    **(17.5**
    **)**
    
    (0.8
    )
    
    -Cumulative
      effect of accounting change for ARO
    
    
    **-**
    
    
    (0.4
    )
    
    0.4**Net
      income (loss) before taxes and extraordinary items for the year ended
      December 31 based on U.S. GAAP**
    
    
    **(0.4**
    **)**
    
    58.8
    
    
    (122.3
    )Income
      tax benefit from future income tax liability (b)
    
    
    **7.9**
    
    
    8.6
    
    
    6.1Change
      in enacted tax rate (d)
    
    
    **(0.3**
    **)**
    
    (1.6
    )
    
    -**Net
      income (loss) before extraordinary items for the year ended December 31
      based on U.S. GAAP**
    
    
    **7.2**
    
    
    65.8
    
    
    (116.2
    )Extraordinary
      item - gain on debt restructuring (b)
    
    
    **-**
    
    
    -
    
    
    1,292.5**Net
      income (loss) after extraordinary items for the year ended December 31
      based on U.S. GAAP**
    
    
    **7.2**
    
    
    65.8
    
    
    1,176.3Unrealized
      gain (loss) on investment available for sale
    
    
    **0.1**
    
    
    0.1
    
    
    (0.1
    )**Comprehensive
      income (loss) for the year ended December 31 based on U.S. GAAP
      (f)**
    
    
    **7.3**
    
    
    65.9
    
    
    1,176.2**U.S.
      GAAP Earnings (Loss) Per Share - Basic**Net
      income (loss) before extraordinary items - basic
    
    
    **0.20**
    
    
    2.40
    
    
    (6.09
    )Extraordinary
      item - basic
    
    
    **-**
    
    
    -
    
    
    67.75**Net
      income (loss) - basic**
    
    
    **0.20**
    
    
    2.40
    
    
    61.66**U.S.
      GAAP Earnings (Loss) Per Share - Diluted**Net
      income (loss) before extraordinary items - diluted
    
    
    **0.20**
    
    
    2.38
    
    
    (6.09
    )Extraordinary
      item - diluted
    
    
    **-**
    
    
    -
    
    
    67.71**Net
      income (loss) - diluted**
    
    
    **0.20**
    
    
    2.38
    
    
    61.62








36





**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]





**Statements
of Cash Flows**





**2004**
    
    2003
    
    2002**Cash
      provided by (used in) operating activities based on Canadian
      GAAP**
    
    
    **86.8**
    
    
    43.7
    
    
    6.1Interest
      expense on long-term debt (b)
    
    
    **32.8**
    
    
    44.6
    
    
    43.6**Cash
      provided by (used in) operating activities based on U.S.
      GAAP**
    
    
    **119.6**
    
    
    88.3
    
    
    49.7**Cash
      provided by (used in) investing activities based on Canadian and U.S.
      GAAP**
    
    
    **2.8**
    
    
    (59.7
    )
    
    154.2**Cash
      provided by (used in) financing activities based on Canadian
      GAAP**
    
    
    **(107.2**
    **)**
    
    38.4
    
    
    (29.9
    )Recapitalization
      adjustments (b)
    
    
    **-**
    
    
    -
    
    
    (111.8
    )Interest
      expense on long-term debt (b)
    
    
    **(32.8**
    **)**
    
    (44.6
    )
    
    (43.6
    )**Cash
      provided by (used in) financing activities based on U.S.
      GAAP**
    
    
    **(140.0**
    **)**
    
    (6.2
    )
    
    (185.3
    )**Net
      increase (decrease) in cash and cash equivalents for the 12 months ended
      December 31 based on U.S. GAAP**
    
    
    **(17.6**
    **)**
    
    22.4
    
    
    18.6




(a)
    Under
      Canadian GAAP, portfolio investments are accounted for at the lower of
      cost and market. Under U.S. GAAP, portfolio investments classified as
      available for sale are carried at market values with unrealized gains or
      losses reflected as a component of other comprehensive
    income.(b)
    Under
      Canadian GAAP, the Company’s capital reorganization and comprehensive
      revaluation of assets and liabilities is accounted for under fresh start
      accounting. U.S. GAAP does not recognize the recapitalization adjustments,
      writedowns and the elimination of the deficit made under fresh start
      accounting*[note
      1].*Under
      U.S. GAAP, the Company’s debt restructuring is accounted for in accordance
      with Statement of Financial Accounting Standards No. 15, ’Accounting by
      Debtors and Creditors for Troubled Debt Restructuring‘ [‘SFAS 15’]. The
      fair value of the equity interest granted to Sprint of $25.0 and the fair
      value of the equity interest granted to the noteholders of $163.1, reduced
      by direct issuance costs of $0.2, are added to capital stock.The
      net reduction in the value of other in-use capital assets of $11.1 (fair
      value increments of $89.7 and decrements of $100.8) made under Canadian
      GAAP under fresh start accounting did not apply under U.S. GAAP. In 2004,
      the Company wrote down the Cable and Wireless IRU for U.S. GAAP purposes
      in the amount of $17.5, which had been previously written down for
      Canadian GAAP under fresh start accounting. Under U.S. GAAP, an additional
      ($1.1) of depreciation would have been expensed during 2004 [2003 - $1.5;
      2002 - $1.6].Under
      Canadian GAAP, the first quarter of 2002 royalty payment to Sprint of $4.9
      was accounted for under the restructuring. Under U.S. GAAP, the payment is
      included in the statement of operations of the current
    period.Under
      U.S. GAAP, the gain on debt restructuring is determined in accordance with
      SFAS 15. The fair value of the assets transferred to the noteholders
      include cash and an equity interest, net of issuance costs. The remaining
      direct costs of the Plan of Arrangement of $18.3 are deducted in measuring
      the gain on restructuring. Also included in the determination of the gain
      is the carrying amount of the pre-recapitalization notes cancelled, and
      accrued interest thereon, net of related deferred financing costs,










37




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


and
      the carrying amount of the newly issued senior secured notes due 2008,
      accrued interest thereon, and future interest payments.Under
      U.S. GAAP, all cash payments under the terms of the senior secured notes
      are accounted for as reductions of the liability, and no interest expense
      is recognized over the remaining life of the debt. Under Canadian GAAP,
      interest expense is recognized in the statement of
    operations.Under
      Canadian GAAP, the future income tax liability was valued at nil under the
      application of fresh start accounting. Under U.S. GAAP, the value of the
      future income tax liability is not impacted by the debt
      restructuring.Under
      Canadian GAAP, the benefit of tax items that arose prior to the
      application of fresh start accounting of $3.9 [2003 - $4.3] are recorded
      through a reduction of unamortized customer relationships. Under U.S.
      GAAP, the reduction is not applied.Additional
      information regarding the Company’s financial reorganization is presented
      in note 1.(c)
    Under
      U.S. GAAP, interest expense to date of $4.9 [2003 - $5.9, 2002 - $7.1]
      would have been capitalized as part of the cost of constructing fibre
      optic cable and buildings and therefore included in the cost of the assets
      in determining the losses on disposal. Under Canadian GAAP, these amounts
      have been expensed.(d)
    Under
      Canadian GAAP, future income tax liabilities are valued using the income
      tax rates expected to apply when the liability is settled or the asset is
      realized based on substantively enacted income tax rates. Under U.S. GAAP,
      income tax rates applied are based on those completely enacted into
      law.(e)
    Canadian
      GAAP allows for the reduction of the stated capital of outstanding shares
      with a corresponding offset to deficit. This reclassification which the
      Company made in 1992 is not permitted by U.S. GAAP.(f)
    U.S.
      GAAP SFAS 130 requires the presentation of comprehensive income and its
      components. Comprehensive income includes all changes in equity during a
      period except shareholder transactions.(g)
    U.S.
      GAAP does not recognize the disclosure of any subtotal of the amount of
      cash, cash equivalents and short-term investments in the consolidated
      balance sheets.(h)
    U.S.
      GAAP does not recognize the disclosure of a subtotal of the cash flow from
      operations before net change in non-cash working capital items in the
      consolidated statements of cash flows.











38




**Call-Net
Enterprises Inc.**
 
 **NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS**
 
 Year
ended December 31, 2004
 [millions
of Canadian dollars, unless otherwise indicated]


**Additional
Information**





Selling, general
and administration costs of $284.1 [2003 - $267.5; 2002 - $250.4], advertising
costs of $14.6 [2003 - $14.2; 2002 - $18.4], lease rental costs of $14.5 [2003 -
$15.0; 2002 - $15.0], and bad debt costs of ($0.1) [2003 - $0.9; 2002 - $16.6]
were expensed as incurred during the year under both Canadian and U.S.
GAAP.





**Accounting
Changes**





The Financial
Accounting Standards Board [the ’FASB‘] has issued Interpretation No. 46,
’Consolidation of Variable Interest Entities‘ [‘FIN 46‘]. FIN 46 clarifies the
application of consolidation to those entities defined as ‘variable interest
entities’ [‘VIEs’], which are certain entities in which equity investors do not
have the characteristics of a ‘controlling financial interest’ or there is not
sufficient equity at risk for the entity to finance its own activities without
additional subordinated financial support. VIEs will be consolidated by the
Company when it is determined that it will, as the primary beneficiary, absorb
the majority of the VIEs expected losses and/or expected residual returns. The
Company has reviewed this interpretation and determined there is no impact as a
result of adopting FIN 46.





In December 2002,
the FASB issued Statement of Financial Accounting Standards [‘SFAS’] No. 148,
‘Accounting for Stock-Based Compensation - Transition and Disclosure - an
Amendment of FASB Statement No. 123’ [‘SFAS 148’], which amended the
transitional provisions of SFAS No. 123, ‘Accounting for Stock-based
Compensation’ [‘SFAS 123’], for companies electing to recognize employee
stock-based compensation using the fair value based method. Effective January 1,
2004, the Company elected to expense employee stock-based compensation using the
fair value method, with retroactive restatement of prior periods. Previously,
the intrinsic value method had been used to account for allowed employee awards
under U.S. GAAP. As all of the Company’s stock options were granted subsequent
to January 1, 2002, the impact of adoption of the fair value method under U.S.
GAAP was consistent with Canadian GAAP.





**21.**
    **SUBSEQUENT
      EVENT**





On February 3,
2005, the CRTC released a decision to lower the price of competitor digital
network access (CDNA) facilities and services provided to competitive local
exchange carriers.  Based on the inventory of circuits and contracts in
place with carriers as at December 31, 2004, this decision is expected to reduce
carrier charges by more than $25.0 per annum.  In addition, the decision
was partially retroactive to June 2002. The retroactive portion is estimated to
be approximately $1.0 to $2.0 which will reduce carrier charges in the first
quarter of 2005.




39