EXHIBIT 3

MANAGEMENTS RESPONSIBILITY FOR FINANCIAL REPORTING



The accompanying consolidated financial statements of CryptoLogic Inc. are the responsibility of Management and have been approved by the Board of Directors.



The consolidated financial statements have been prepared by Management in accordance with Canadian generally accepted accounting principles. These statements include some amounts that are based on best estimates and judgment. Management has determined such amounts on a reasonable basis in order to ensure that the financial statements are presented fairly, in all material respects.



CryptoLogics policy is to maintain systems of internal accounting and administrative controls of high quality, consistent with reasonable cost. Such systems are designed to provide reasonable assurance that the financial information is relevant, accurate and reliable and that the Companys assets are appropriately accounted for and adequately safeguarded.



The Board of Directors is responsible for ensuring that Management fulfills its responsibilities for financial reporting and is ultimately responsible for approving the financial statements. The Board carries out this responsibility principally through its Audit Committee.



The Audit Committee is appointed by the Board and is comprised of a majority of outside Directors. The committee meets periodically with Management and the external auditors to discuss internal controls over the financial reporting process, auditing matters and financial reporting issues to satisfy itself that each party is properly discharging its responsibilities. The Audit Committee reviews the Companys annual consolidated financial statements, the external auditors report and other information in the Annual Report. The committee reports its findings to the Board for consideration by the Board when it approves the financial statements for issuance to the shareholders.



On behalf of the shareholders, the financial statements have been audited by KPMG LLP, the external auditors, in accordance with Canadian generally accepted auditing standards. KPMG LLP has full and free access to the Audit Committee.





|/s/LEWIS ROSE     | /s/STEPHEN TAYLOR      
|----------------- | -----------------------
|Lewis Rose        | Stephen Taylor         
|President and CEO | Chief Financial Officer
|                  |                        





February 13, 2007























---













Consolidated Financial Statements

(In U.S. dollars)



CRYPTOLOGIC INC.



Years ended December 31, 2006 and 2005



---







AUDITORS REPORT TO THE SHAREHOLDERS

We have audited the consolidated balance sheets of CryptoLogic Inc. as at December 31, 2006 and 2005 and the consolidated statements of earnings, retained earnings and cash flows for the years then ended. 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 audits.

We conducted our audits 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, 2006 and 2005 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles.



Chartered Accountants

/s/KPMG

Toronto, Canada

February 13, 2007



---







CRYPTOLOGIC INC.

Consolidated Balance Sheets

(In thousands of U.S. dollars)



December 31, 2006 and 2005



|                                        
|----------------------------------------
|
|                                        
|Assets                                  
|Current assets:                         
|Cash and cash equivalents               
|Security deposits (note 2)              
|Short-term investments                  
|Accounts receivable and other           
|Prepaid expenses                        
|                                        
|                                        
|User funds on deposit (note 3)          
|Capital assets (note 4)                 
|Intangible assets (note 5)              
|Goodwill                                
|                                        
|                                        
|                                        
|Liabilities and Shareholders Equity    
|Current liabilities:                    
|Accounts payable and accrued liabilities
|Income taxes payable                    
|                                        
|                                        
|User funds held on deposit (note 3)     
|Future income taxes (note 12)           
|                                        
|                                        
|                                        
|Shareholders equity:                   
|Share capital (note 7)                  
|Stock options (note 8)                  
|Retained earnings                       
|                                        
|                                        
|Commitments and contingencies (note 9)  
|Subsequent event (note 16)              
|                                        
|                                        
|                                        

See accompanying notes to consolidated financial statements.

On behalf of the Board:



|/s/ROBERT H. STIKEMAN | Director, Chairman
|--------------------- | ------------------

/s/LEWIS N. ROSEDirector



1



---







CRYPTOLOGIC INC.

Consolidated Statements of Earnings

(In thousands of U.S. dollars, except per share disclosure)



Years ended December 31, 2006 and 2005



|                                    
|------------------------------------
|
|                                    
|Revenue                             
|                                    
|Expenses:                           
|Operating                           
|General and administrative          
|Reorganization (note 11)            
|Software development (note 4)       
|Finance                             
|Amortization                        
|                                    
|                                    
|                                    
|Earnings before the undernoted      
|Interest income                     
|                                    
|Earnings before income taxes        
|                                    
|Income taxes (recovery) (note 12):  
|Current                             
|Future                              
|                                    
|                                    
|                                    
|Earnings                            
|                                    
|Earnings per common share (note 10):
|Basic                               
|Diluted                             
|                                    

See accompanying notes to consolidated financial statements.



2



---







CRYPTOLOGIC INC.

Consolidated Statements of Retained Earnings

(In thousands of U.S. dollars)



Years ended December 31, 2006 and 2005



|                                    
|------------------------------------
|
|                                    
|Retained earnings, beginning of year
|                                    
|Earnings                            
|                                    
|Dividends paid                      
|                                    
|Excess of purchase price of treasury
|shares over stated value (note 7)   
|                                    
|Retained earnings, end of year      
|                                    

See accompanying notes to consolidated financial statements.



3

---







CRYPTOLOGIC INC.

Consolidated Statements of Cash Flows

(In thousands of U.S. dollars)



Years ended December 31, 2006 and 2005



|                                                  
|--------------------------------------------------
|
|                                                  
|Cash flows from (used in) operating activities:   
|Earnings                                          
|Adjustments to reconcile earnings to cash         
|provided by (used in) operating activities:       
|Amortization                                      
|Future income taxes                               
|Stock options                                     
|                                                  
|                                                  
|Change in operating assets and liabilities:       
|Security deposits                                 
|Accounts receivable and other                     
|Prepaid expenses                                  
|Accounts payable and accrued liabilities          
|Income taxes payable                              
|                                                  
|                                                  
|Cash flows from (used in) financing activities:   
|Issue of capital stock                            
|Repurchase of common shares                       
|Dividends paid                                    
|                                                  
|                                                  
|                                                  
|Cash flows from (used in) investing activities:   
|Purchase of intangible assets                     
|Additions to capital assets                       
|Short-term investments                            
|                                                  
|                                                  
|                                                  
|Increase (decrease) in cash and cash equivalents  
|Cash and cash equivalents, beginning of year      
|                                                  
|Cash and cash equivalents, end of year            
|                                                  
|Supplemental cash flow information:               
|Income taxes paid                                 
|Interest received                                 
|Non-cash portion of options and warrants exercised
|                                                  

See accompanying notes to consolidated financial statements.



4



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



CryptoLogic Inc. (the Company)
is a software development company with leading proprietary commerce-enabling technology,
permitting secure, reliable, high-speed and private financial transactions over the
Internet. Substantially all of the Companys revenue is earned in U.S. dollars,
British pounds and Euros in the form of licensing fees and support services from
licensees located outside of North America. Revenue from the top seven licensees
constituted 84% (2005 - 90%) of revenue. The licensees internet businesses are
licensed by the government of the Netherlands Antilles.  The Company measures and reports
its results in U.S. dollars.

|1. |  | Significant
accounting policies:
|-- |  | --------------------------------

| | The
consolidated financial statements are prepared in accordance with Canadian generally
accepted accounting principles (GAAP). Note 18 describes and reconciles the
significant measurement differences between Canadian and U.S. GAAP affecting the
accompanying consolidated financial statements. A summary of significant accounting
policies is set out below:
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (a) |  | Basis
of presentation:
| | --- |  | ----------------------

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

| | (b) |  | Revenue
recognition:
| | --- |  | --------------------

| | The
Company enters into non-exclusive gaming software hosting, licensing and services
arrangements related to the design and operation of casino sites on the internet on
behalf of licensed casinos.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Revenue
from software hosting and support services to licensees is recognized, as the services
are performed, on a daily basis, at the time of the gaming transactions, pursuant to the
agreements with the licensees in which the Company participates in a pro rata share of
the daily gaming profits. In addition, the Company receives a standard monthly fee for
the provision of hosting and related services.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



5



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|1. |  | Significant
accounting policies (continued):
|-- |  | --------------------------------------------

| | Revenue
from the customization of the software graphics, sound and texts to the specifications of
the licensees is recognized on a straight-line basis over the term of the software and
support agreements.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Interest
income is recognized on an accrual basis.
| | --------------------------------------------------

| | (c) |  | Cash
and cash equivalents:
| | --- |  | --------------------------

| | Cash
and cash equivalents include highly liquid investments with original maturity dates of 90
days or less, and are stated at cost, which approximates market value.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (d) |  | Short-term
investments:
| | --- |  | -----------------------

| | Short-term
investments include highly liquid investments (primarily certificates of deposit and
commercial paper) with original maturity dates between 3 and 12 months, and are
stated at the lower of cost or market value. At the balance sheet date, cost approximates
market value.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (e) |  | Capital
assets:
| | --- |  | ---------------

| | Capital
assets are stated at cost less accumulated amortization. Amortization, based on the
estimated useful lives of the assets, is provided using the following methods and annual
rates:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                
|--------------------------------
|
|                                
|Computer equipment              
|Office furniture and equipment  
|Computer software and licenses  
|Capitalized software development
|Leasehold improvements          
|                                

6



---





CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|1. |  | Significant
accounting policies (continued):
|-- |  | --------------------------------------------

| | (f) |  | Software
development:
| | --- |  | ---------------------

| | Costs
related to the development of software are expensed as incurred unless such costs meet
the criteria for deferral and amortization under Canadian generally accepted accounting
principles. Under The Canadian Institute of Chartered Accountants (CICA)
Handbook Section 3450, Research and Development Costs, the Company capitalizes
certain computer software development costs incurred subsequent to establishing
technological feasibility; and amortizes the capitalized software development costs using
the straight-line method over the estimated useful life of the software once the software
is available for general release.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (g) |  | Provision
for jackpots:
| | --- |  | -----------------------

| | Each
time certain casino games are played, a preset amount is added to a cumulative jackpot
for that specific game. The jackpot is won on a random basis by a player on a licensee
website. The Company is liable for funding the jackpot wins and accrues the jackpot
amount for all games on a monthly basis. The jackpot provision is reduced when payment is
made to a winning player. The accrual for the jackpot at the balance sheet date is
included in accounts payable and accrued liabilities.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (h) |  | Income
taxes:
| | --- |  | -------------

| | The
Company uses the asset and liability method of accounting for income taxes. Future income
tax assets and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss carry forwards. Future
income tax assets and liabilities are measured using enacted or substantively enacted tax
rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on future income tax
assets and liabilities of a change in tax rates is recognized in income in the year that
includes the enactment or substantive enactment date.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



7



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005





---

|1. |  | Significant
accounting policies (continued):
|-- |  | --------------------------------------------

| | (i) |  | Stock-based
compensation:
| | --- |  | -------------------------

| |  | (i) |  | Stock
options:
| |  | --- |  | --------------

| | The
Company has a stock option plan for directors, officers and other key employees.
Effective January 1, 2003, the Company adopted the amended recommendations of CICA with
respect to accounting for stock-based compensation and other stock-based payments. The
Company applies the fair value method to all grants of stock options. Based on the
transitional provisions, all stock options granted on or after January 1, 2003 are
accounted for as capital transaction at the time of the grant and are reflected as stock
options in shareholders equity. The fair value of options granted is estimated at
the date of grant using the Black-Scholes option pricing model incorporating assumptions
regarding risk-free interest rates, dividend yield, volatility factor of the expected
market price of the Companys stock and a weighted average expected life of options.
The estimated fair value of the options is recorded over the options vesting
period. Any consideration paid on the exercise of stock options is credited to share
capital.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | (ii) |  | Long-term
incentive plan:
| |  | ---- |  | -------------------------

| | Effective
January 1, 2005, the Company introduced a long-term incentive plan for its officers and
directors. The plan provides for the granting of performance share units to reward
participants for the growth in the Companys earnings per share, calculated on a
fully diluted basis, and share price, with vesting over a three-year performance period.
These awards are settled in cash upon vesting and therefore are recorded as a liability
and included in accounts payable and accrued liabilities on the consolidated balance
sheet.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Changes
in this liability, which arise from fluctuations in the Companys stock price and
estimated future diluted earnings per share, are recorded in operating costs over the
vesting period.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



8



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|1. |  | Significant
accounting policies (continued):
|-- |  | --------------------------------------------

| | (j) |  | Foreign
currency translation:
| | --- |  | -----------------------------

| | Monetary
items denominated in currencies other than U.S. dollars are translated into U.S. dollars
at exchange rates in effect at the balance sheet dates, and non-monetary items are
translated at rates of exchange in effect when the assets were acquired or obligations
incurred. Revenue and expenses are translated at rates in effect at the time of the
transactions. Foreign exchange gains and losses are included in the consolidated
statements of earnings.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (k) |  | Intangible
assets:
| | --- |  | ------------------

| | Intangible
assets consist of customer lists and domain names and are amortized over their useful
lives, generally three to five years.
| | --------------------------------------------------------------------------------------------------------------------------------------

| | (l) |  | Goodwill:
| | --- |  | ---------

| | Goodwill
is the residual amount that results when the purchase price of an acquired business
exceeds the sum of the amounts allocated to the assets acquired, less liabilities
assumed, based on their fair values.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Goodwill
is not amortized and is tested for impairment annually, or more frequently, if events or
changes in circumstances indicate that the asset might be impaired. The impairment test
is carried out in two steps. In the first step, the carrying amount of the reporting unit
is compared with its fair value. When the fair value exceeds its carrying amount,
goodwill is considered not to be impaired and the second step of the impairment test is
unnecessary. The second step is carried out when the carrying amount of the reporting
unit exceeds its fair value, in which case, the implied fair value of the goodwill is
compared with its carrying amount to measure the amount of the impairment loss, if any.
The implied fair value of goodwill is determined in the same manner as the value of
goodwill is determined in a business combination described in the preceding paragraph,
using the fair value of the reporting unit as if it was the purchase price. When the
carrying amount of goodwill exceeds the implied fair value of the goodwill, an impairment
loss is recognized in an amount equal to the excess and is presented as a separate line
item in the statements of earnings.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | For
the years ended December 31, 2006 and 2005, the Company assessed impairment of goodwill
and has determined that there was no impairment in value.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------



9



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005





---



|1. |  | Significant
accounting policies (continued):
|-- |  | --------------------------------------------

| | (m) |  | Earnings
per common share:
| | --- |  | --------------------------

| | The
Company uses the treasury stock method in computing diluted earnings per common share.
The treasury stock method is a method of recognizing the use of proceeds that could be
obtained upon the exercise of options and warrants in computing diluted earnings per
common share. It assumes that any proceeds would be used to purchase its common shares at
the average market price during the year being reported on.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (n) |  | Variable
interest entities:
| | --- |  | ---------------------------

| | In
June 2003, the CICA issued Accounting Guideline 15, Variable Interest Entities (AcG-15),
which became applicable to the Company on January 1, 2005. Variable interest entities (VIEs)
include entities in which the equity investors do not have a controlling financial
interest or the equity investment at risk is not sufficient to permit the entity to
finance its activities without additional subordinated financial support by other parties.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Management
assessed the Companys operations and relationships in light of AcG-15 and concluded
that there are no VIEs in respect of which the Company is the primary beneficiary.
Accordingly, no VIEs are consolidated in the consolidated financial statements.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (o) |  | Use
of estimates:
| | --- |  | -----------------

| | The
preparation of financial statements 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 revenue and expenses during the year. Actual amounts could differ
from those estimates.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (p) |  | Recent
accounting pronouncements - financial instruments:
| | --- |  | ---------------------------------------------------------

| | In
January 2005, the CICA issued Handbook Section 3855, Financial Instruments -
Recognition and Measurement, Handbook Section 1530, Comprehensive Income, and
Handbook Section 3865, Hedges. The new standards will be effective for the Company
for interim and annual periods commencing January 1, 2007.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



10



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|1. |  | Significant
accounting policies (continued):
|-- |  | --------------------------------------------

| | The
new standards will require presentation of a separate consolidated statement of
comprehensive income and the classification of financial instruments as held for
trading, held-to-maturity or available-for-sale.
Comprehensive income is the change in net equity of an enterprise during a period from
transactions and other events and circumstances from non-owner sources.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Upon
adoption of these standards, the Company will classify its short-term investments as held
for trading instruments. Management does not expect that the adoption of these standards
will have a material impact on the Companys consolidated financial statements.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|2. |  | Security
deposits:
|-- |  | ------------------

| | Security
deposits are amounts held by the Companys bank as collateral provided to foreign
banks and payment processors that process deposit and credit card transactions.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|3. |  | User
funds on deposit:
|-- |  | ----------------------

| | User
funds on deposit represent amounts deposited by end users of licensees for playing online
games. These funds are treated as deposits of the end users until such games are played.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|4. |  | Capital
assets:
|-- |  | ---------------



|                                
|--------------------------------
|
|                                
|Computer equipment              
|Office furniture and equipment  
|Computer software and licenses  
|Capitalized software development
|Leasehold improvements          
|                                
|                                
|                                



11





---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005





---



|4. |  | Capital
assets (continued):
|-- |  | ---------------------------

|                                
|--------------------------------
|
|                                
|Computer equipment              
|Office furniture and equipment  
|Computer software and licenses  
|Capitalized software development
|Leasehold improvements          
|                                
|                                
|                                

| | Amortization
expense of capital assets during the year was $4,748 (2005 - $3,863).
| | ----------------------------------------------------------------------------------

| | During
2005, the Company determined that certain software being developed no longer met the
criteria for capitalization. As a result of this decision, the Company expensed $2,744 of
software development costs incurred in 2005. Together with severances of $543, the
Company took a total charge against earnings of $3,287 in 2005.
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
change in the estimated useful lives of computer equipment and office furniture and
equipment resulted in additional amortization expense of $681 in 2006.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------

|5. |  | Intangible
assets:
|-- |  | ------------------

| | Intangible
assets consist of customer lists and domain names. At December 31, 2006 and 2005,
customer lists with a cost of $315 have been fully amortized. At December 31, 2006,
domain names have a cost of $157 (2005 - $157) and a net book value of $48 (2005 - $77).
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|6. |  | Credit
facilities:
|-- |  | ------------------

| | The
Company has an operating credit facility with a Canadian chartered bank in the amount of
$3,000. No amount has been utilized under this line in 2006 and 2005.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



12



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|7. |  | Share
capital:
|-- |  | --------------

| | (a) |  | Authorized:
| | --- |  | -----------

| | Unlimited
common shares
| | -----------------------

| | Issued
and outstanding:
| | -----------------------

|                          
|--------------------------
|
|
|                          
|Balance, December 31, 2004
|Repurchase and            
|cancellation of shares    
|Exercise of stock options 
|Exercise of Series F      
|purchase warrants         
|Expiry of Series F        
|purchase warrants         
|                          
|Balance, December 31, 2005
|Exercise of stock options 
|                          
|Balance, December 31, 2006
|                          



13



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005

---

|7. |  | Share
capital (continued):
|-- |  | --------------------------

| | (b) |  | Normal
course issuer bid:
| | --- |  | -------------------------

| | During
2006 and 2005 under normal course issuer bids, the Board of Directors approved the
repurchase and cancellation of up to the following number of shares representing 10% of
the outstanding common shares at that time:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                      
|----------------------
|
|                      
|
|                      
|September 23, 2004 to 
|September 22, 2005    
|                      
|September 28, 2005 to 
|September 27, 2006    
|                      
|September 29, 2006, to
|September 28, 2007    
|                      

| | Under
the September 23, 2004 to September 22, 2005 bid, the Company repurchased and cancelled
270,500 common shares during 2005 for a total cost of $5,225, of which $4,722,
representing the excess of purchase price over stated value, was charged to retained
earnings.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Under
the September 28, 2005 to September 27, 2006 bid, the Company repurchased and cancelled
239,200 common shares during 2005 for a total cost of $3,976, of which $3,526,
representing the excess of purchase price over stated value, was charged to retained
earnings.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
September 2006, the Board of Directors approved the renewal of the above share purchase
plan, under a normal course issuer bid, to repurchase and cancel up to 1,350,000 of the
Companys outstanding common shares for the period commencing September 29, 2006 and
ending September 28, 2007. As at December 31, 2006, the Company had not repurchased any
shares from the renewed normal course issuer bid.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



14



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|8. |  | Stock-based
compensation:
|-- |  | -------------------------

| | (a) |  | Stock
option plan:
| | --- |  | ------------------

| | Under
the stock option plan, the Company may grant options to directors, officers and other key
employees to purchase common shares. Under the plan, a maximum of 3,000,000 common shares
may be issued. The exercise price of the options may not be less than the market value of
the underlying common shares on the date of grant. The Company does not grant stock
options with an exercise price below the market value at the date of grant. There are
781,350 (2005 - 351,695) common shares available to be issued under the stock option plan
as at December 31, 2006. Options typically vest over a period of three or four years
and the term of the options may not exceed five years.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | Details
of stock option transactions are as follows:
| | ----------------------------------------------------

|                    
|--------------------
|
|                    
|
|                    
|
|                    
|Options outstanding,
|beginning of year   
|Granted             
|Exercised           
|Forfeited           
|                    
|Options outstanding,
|end of year         
|                    
|Options exercisable,
|end of year         
|                    



15



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|8. |  | Stock-based
compensation (continued):
|-- |  | -------------------------------------

|             
|-------------
|
|             
|
|             
|
|             
|
|             
|$5.00-$10.00 
|$10.01-$15.00
|$15.01-$20.00
|$20.01-$25.00
|$25.01-$30.00
|$30.01-$35.00
|$35.01-$40.00
|             
|             
|             

|             
|-------------
|
|             
|
|             
|
|             
|
|             
|$5.00-$10.00 
|$5.00-$10.00 
|$10.01-$15.00
|$15.01-$20.00
|$20.01-$25.00
|$25.01-$30.00
|$30.01-$35.00
|$35.01-$40.00
|$40.01-$45.00
|             
|             
|             



16



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|8. |  | Stock-based
compensation (continued):
|-- |  | -------------------------------------

| | The
Company expenses the cost of all stock option grants issued on or after January 1, 2003,
determined using the fair value method. The estimated fair value of the options is
recorded over the periods that the options vest. The fair value of options granted were
estimated using the Black-Scholes option pricing model with the following weighted
average assumptions:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                 
|---------------------------------
|
|                                 
|Dividend yield                   
|Risk-free interest rate          
|Expected volatility              
|Expected life of options in years
|                                 

| | The
weighted average fair value of options granted during 2006 was $9.98 (2005 - $9.49).
| | ----------------------------------------------------------------------------------------

| | Included
in operating costs is the cost of stock options in the amount of $2,255 (2005 - $1,807).
| | -------------------------------------------------------------------------------------------------

| | For
the year ended December 31, 2002, no compensation cost was recorded on the grant of stock
options during that year. In accordance with the transitional provisions related to the
CICA Handbook, additional pro forma disclosure is provided as if the fair value method of
accounting had been used to account for these stock options. The fair value of options
granted in 2002 was determined using the Black-Scholes option pricing model, using the
following weighted average assumptions:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                 
|---------------------------------
|Dividend yield                   
|Risk-free interest rate          
|Expected volatility              
|Expected life of options in years
|                                 



17



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005





|8. |  | Stock-based
compensation (continued):
|-- |  | -------------------------------------

| | Had
compensation expense been determined based on the fair value of the employee stock option
awards at the grant dates in accordance with the new accounting recommendations, the
Companys earnings and earnings per share for the year would have been changed to
the following pro forma amounts:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                          
|--------------------------
|
|                          
|
|                          
|Earnings                  
|                          
|Earnings per common share:
|Basic                     
|Diluted                   
|                          

| | For
stock options issued in 2002, the compensation cost for the year ended December 31, 2006
would have been $375 (2005 - $542).
| | --------------------------------------------------------------------------------------------------------------------------------

| | (b) |  | Long-term
incentive plan:
| | --- |  | -------------------------

| | During
the year, the Company expensed $2,028 (2005 - $430) in costs related to units awarded
under its long-term incentive plan, of which $346 is included in reorganization expense
as a result of accelerated vesting for certain employees with termination agreements.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



18



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|9. |  | Commitments
and contingencies:
|-- |  | ------------------------------

| | (a) |  | The
Company has operating lease agreements for premises expiring at various periods up to
July 2015. The future minimum annual rental payments on the operating leases are as
follows:
| | --- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|           | 
|---------- | 
|          
|2007       | 
|2008       | 
|2009       | 
|2010       | 
|2011       | 
|Thereafter | 
|          

| | (b) |  | The
Company has guaranteed minimum payments for certain intellectual property rights up to
2010:
| | --- |  | ------------------------------------------------------------------------------------------------

|     | 
|---- | 
|    
|2007 | 
|2008 | 
|2009 | 
|2010 | 
|    

| | (c) |  | The
Company and its subsidiaries are involved in certain claims and litigation arising out of
the ordinary course and conduct of business including intellectual property matters.
Management assesses such claims, and if considered likely to result in material exposure
and where the amount of the claim is quantifiable, provisions for loss are made based on
managements assessment of the likely outcome. Management does not provide for
claims that are considered unlikely to result in a significant loss, claims for which the
outcome is not determinable or claims where the amount of the loss cannot be reasonably
estimated. Any settlements or awards under such claims are provided for when reasonably
determinable.
| | --- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



19



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|10. |  | Earnings
per common share:
|--- |  | --------------------------

| | Basic
and diluted earnings per common share were calculated using the weighted average number
of common shares and the weighted average number of common shares on a diluted basis.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                 
|---------------------------------
|
|                                 
|
|                                 
|Weighted average number of common
|shares outstanding               
|Weighted average number of common
|shares outstanding - diluted     
|                                 

| | Basic
and diluted earnings per common share are as follows:
| | -----------------------------------------------------------

|                          
|--------------------------
|
|                          
|Earnings                  
|                          
|Earnings per common share:
|Basic                     
|Diluted                   
|                          

| | Options
to purchase 193,625 common shares (2005 - 54,338) were excluded from the computation of
diluted earnings per share as the exercise price exceeded the average market price of
common shares for the reporting year.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



20



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|11. |  | Reorganization:
|--- |  | ---------------

| | On
September 25, 2006, the Company announced a plan to move the corporate head office to
Ireland in 2007 to be located in a gaming friendly environment. Total expected cost to be
incurred is $8,500 largely related to professional fees, search fees, relocation and
employee severance.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                         | 
|---------------------------------------- | 
|                                        
|Accrual, December 31, 2005               | 
|Professional fees                        | 
|Employee severance                       | 
|Employee relocation and recruitment      | 
|                                        
|                                         | 
|Payments                                 | 
|                                        
|Included in accounts payable and         | 
|accrued liabilities at December 31, 2006 | 
|                                        

|12. |  | Income
taxes:
|--- |  | -------------

| | The
income tax provision differs from the amount which would be obtained by applying the
Canadian statutory income tax rate to the earnings before income taxes. The following
explains the major differences:
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                                           
|-----------------------------------------------------------
|
|                                                           
|Earnings before income taxes                               
|                                                           
|Income taxes based on a statutory rate of 36.12%           
|(2005 - 36.12%)                                            
|Increase (decrease) in income taxes resulting from:        
|Lower effective income tax rates in foreign jurisdictions  
|Tax cost of non-deductible items                           
|Recognition of tax benefit of non-capital loss carryback   
|Recognition of tax benefit on non-capital loss carryforward
|Other                                                      
|                                                           
|Actual income tax expense                                  
|                                                           



21



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|12. |  | Income
taxes (continued):
|--- |  | -------------------------

| | The
tax effects of temporary differences that give rise to significant portions of the future
income tax assets and future income tax liabilities at December 31, 2006 and 2005
are as follows:
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                                 
|---------------------------------
|
|                                 
|Future income tax assets:        
|Long-term incentive plan         
|Capital assets                   
|Provisions for known matters     
|                                 
|                                 
|Future income tax liabilities:   
|Capital items                    
|Unrealized foreign exchange gains
|                                 
|                                 
|Less valuation allowance         
|                                 
|Net future income tax liabilities
|                                 

|13. |  | Related
party transactions:
|--- |  | ---------------------------

| | In
the normal course of operations, the Company currently engages the services of a law firm
in which a member of the Board of Directors is a partner. Fees paid to this firm were
$653 (2005 - $589).
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | In
2005, the Company purchased, in the normal course of operations, software from another
company in which a member of the Companys executive has a personal interest.
Payments to this individual in 2006 relating to this transaction amounted to $43 (2005 -
$145).
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|14. |  | Foreign
exchange:
|--- |  | -----------------

| | In
2006, the Company recognized a total foreign exchange gain of $574 (2005 - foreign
exchange loss of $1,761).
| | ---------------------------------------------------------------------------------------------------------------



22





---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005





---



|15. |  | Financial
instruments:
|--- |  | ----------------------

| | (a) |  | Fair
values:
| | --- |  | ------------

| | The
carrying values of financial instruments, which consist of cash and cash equivalents,
security deposits, short-term investments, accounts receivable and other, user funds on
deposit, accounts payable and accrued liabilities and user funds held on deposit,
approximate their fair values due to the short-term nature of these financial instruments.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) |  | Interest
rate:
| | --- |  | --------------

| | The
weighted average effective interest rate on short-term investments as at December 31,
2006 is 5.30% (2005 - 4.20%).
| | -----------------------------------------------------------------------------------------------------------------------

|16. |  | Subsequent
event:
|--- |  | -----------------

| | On
January 15, 2007, the Company signed an agreement to purchase the poker brand and related
assets of Parbet.com, a Norwegian company. Under this agreement, the Company paid cash of
$11,867 for the brand and assets of Parbet.com, and may potentially pay additional
amounts up to a maximum of $5,274, contingent on improved performance of the assets over
a six-month earn- out period.
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|17. |  | Product
revenue:
|--- |  | ----------------

| | The
Company develops and hosts software that allows licensees to provide online casino and
poker games and considers this activity to be one reportable segment. Revenue from
licensing software for online casino and poker games in 2006 was $59,211 (2005 - $52,998)
and $33,934 (2005 - $27,013), respectively.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



23



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|18. |  | Differences
between Canadian and United States generally accepted accounting principles:
|--- |  | ----------------------------------------------------------------------------------------

| | On
January 1, 2006, the Company adopted, on a modified prospective basis, FASB Statement No.
123 (revised 2004), Share-Based Payment (FAS 123(R)) for new awards granted
on or after this date under the Companys stock option and long-term incentive plans
and for the unvested portion of existing awards on January 1, 2006.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (a) |  | Stock
options:
| | --- |  | --------------

| | Under
Canadian GAAP, the Company does not estimate forfeitures in determining the expense to be
recognized over the service period and forfeitures are accounted for as they occur. FAS
123(R) requires an entity to estimate the number of options for which the requisite
service is expected to be rendered.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | On
January 1, 2006, the Company estimated the number of outstanding options for which the
requisite service is not expected to be rendered. Amounts recorded as compensation cost
in earlier years for options outstanding at January 1, 2006 for which requisite service
is not expected to be rendered have been eliminated and recognized in earnings as the
cumulative effect of a change in accounting principle on January 1, 2006.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | The
cumulative effects of adopting FAS 123(R) on January 1, 2006 and the 2006 U.S. GAAP
stock-based compensation adjustment were $601 and $223, respectively. These amounts were
quantified using a weighted average forfeiture rate assumption of 27%.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

| | (b) |  | Long-term
incentive plan:
| | --- |  | -------------------------

| | Under
Canadian GAAP, the Company uses an intrinsic value-based method to record compensation
expense for liability classified awards. The prospective adoption of FAS 123(R)
requires the use of a fair value-based method, rather than an intrinsic value-based
method, to measure and record compensation expense for these awards. The Company has
determined there is no material difference between the intrinsic value and the fair value
of the units awarded under its long-term incentive plan.
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



24



---



CRYPTOLOGIC INC.

Notes to Consolidated Financial Statements (continued)

(In thousands of U.S. dollars, except per share disclosure and where indicated otherwise)



Years ended December 31, 2006 and 2005



---



|18. |  | Differences
between Canadian and United States generally accepted accounting principles (continued):
|--- |  | ----------------------------------------------------------------------------------------------------

| | The
significant measurement differences between Canadian and U.S. GAAP affecting the
consolidated financial statements, as noted above, are as follows:
| | -------------------------------------------------------------------------------------------------------------------------------------------------------

|                                             
|---------------------------------------------
|
|                                             
|Earnings based on Canadian GAAP              
|Adjustment for stock-based compensation (a)  
|                                             
|Earnings based on U.S. GAAP                  
|                                             
|Earnings per common share based on U.S. GAAP:
|Basic                                        
|Diluted                                      
|                                             

| | (c) |  | Guidance
for quantifying financial statement misstatements:
| | --- |  | -----------------------------------------------------------

| | In
September 2006, the Securities and Exchange Commission (SEC) issued Staff
Accounting Bulletin No. 108, Considering the Effects of Prior Year Misstatements when
Quantifying Misstatements in Current Year Financial Statements (SAB 108). SEC
staff issued SAB 108 to address what they identified as diversity in practice whereby
entities were using either an income statement approach or a balance sheet approach, but
not both, when evaluating whether an error is material to an entitys financial
statements. SAB 108 requires that in quantifying and analyzing misstatements, both the
income statement approach and the balance sheet approach should be used to evaluate the
materiality of financial statement misstatements. SAB 108 is effective for the Company
for the year ended December 31, 2006. The Company assessed misstatements using both the
income statement and balance sheet approaches and concluded that misstatements are not
material to the consolidated financial statements under either approach.
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------





25



---