1. Basis of presentation

All monetary amounts in these notes to the consolidated financial statements are in millions, except per share amounts, and in United States ("U.S.") Dollars unless otherwise stated.

Nortel Networks Corporation

Prior to Nortel's significant business divestitures, Nortel Networks Corporation ("Nortel", "NNC" or the "Company") was a global supplier of end-to-end networking products and solutions serving both service providers and enterprise customers. Nortel's technologies spanned access and core networks and support multimedia and business-critical applications. Nortel's networking solutions consisted of hardware, software and services. Nortel designed, developed, engineered, marketed, sold, licensed, installed, serviced and supported these networking solutions worldwide. As further discussed in note 2, Nortel is currently focused on the remaining work under the Creditor Protection Proceedings (as defined in note 2), including providing transitional services to the purchasers of Nortel's businesses, ongoing restructuring matters and the sale of any remaining assets.

As of December 31, 2011, Nortel has completed the sales of all of its businesses, and regarding these businesses, only the residual contracts not transferred to the various buyers remain. As a result, commencing with the first quarter of 2011, Nortel has one reportable segment, being the consolidated entity, as its chief operating decision maker reviews financial and operating results on that basis. Accordingly, Nortel has adjusted previously reported financial information to conform to the change in reportable segments as compared to the prior year.

Nortel Networks Limited ("NNL") is Nortel's principal direct operating subsidiary and its results are consolidated into Nortel's results. Nortel holds all of NNL's outstanding common shares but none of its outstanding preferred shares. NNL's preferred shares are reported in noncontrolling interests in the consolidated balance sheets and dividends accrued on preferred shares are reported in income attributable to noncontrolling interests in the statements of operations. Nortel does not expect to pay any of these cumulative dividends as a result of the Creditor Protection Proceedings.

Consolidated Financial Statements

The consolidated financial statements as of and for the year ended December 31, 2011 have been presented on a consolidated basis to include Nortel and all of its majority owned and controlled subsidiaries.

Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 852 "Reorganization" ("ASC 852"), which is applicable to companies that have filed petitions under applicable bankruptcy code provisions and as a result of the Creditor Protection Proceedings (as defined below) is applicable to Nortel, generally does not change the manner in which financial statements are prepared. However, it does require that the financial statements for periods subsequent to the filing of an applicable bankruptcy petition distinguish transactions and events that are directly associated with reorganization from the ongoing operations of the business. For this reason, Nortel's revenues, expenses, realized gains and losses, and provisions for losses that can be directly associated with the Creditor Protection Proceedings must be reported separately as reorganization items in the statements of operations. The balance sheets must distinguish pre-petition liabilities subject to compromise from both those pre-petition liabilities that are not subject to compromise and from post-petition liabilities. Liabilities that may be affected by a plan of reorganization must be reported at the amounts expected to be allowed, even if they may be settled for lesser amounts. In addition, reorganization items must be disclosed separately in the statements of cash flows. Nortel adopted ASC 852 effective on January 14, 2009 and has segregated those items outlined above for all reporting periods subsequent to such date.

After consideration of the guidance available in ASC 810 "Consolidation" ("ASC 810") and ASC 852, the consolidated financial statements as of and for the years ended December 31, 2011 and 2010 have been presented on the following basis with respect to Nortel subsidiaries:

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the subsidiaries in Europe, the Middle East and Africa ("EMEA"), Nortel Networks UK Ltd. ("NNUK"), Nortel Networks S.A. ("NNSA"), Nortel Networks (Ireland) Limited (collectively, "EMEA Debtors") and their subsidiaries (collectively, "EMEA Subsidiaries") were accounted for under the equity method from the Petition Date up to May 31, 2010 and as an investment under the cost method of accounting thereafter;

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the U.S. subsidiaries and their subsidiaries (collectively, "U.S. Subsidiaries") were accounted for as consolidated subsidiaries until September 30, 2010 and as an investment under the cost method of accounting thereafter; and

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other subsidiaries are consolidated throughout the periods presented consistent with the basis of accounting applied in 2008 prior to the commencement of the Creditor Protection Proceedings with the exception of deconsolidated subsidiaries due to loss of control once these subsidiaries were deemed to be in liquidation proceedings.

Based on Nortel's review of the applicable accounting guidance, Nortel determined that it did not exercise all of the elements of control over the operating and financial policies of the EMEA Subsidiaries once the EMEA Debtors filed for creditor protection, although it continued to exercise significant influence over their operating and financial policies. As a result, in accordance with ASC 810, from the Petition Date (as defined below) to May 31, 2010, Nortel accounted for its interests in the EMEA Subsidiaries under the equity method in accordance with FASB ASC 323 "Investments - Equity Method and Joint Ventures" ("ASC 323"). On the Petition Date, the carrying value of Nortel's investment in the EMEA Subsidiaries was in a net liability position. As the carrying values of the EMEA Subsidiaries' net liabilities were not considered to have differed materially from their estimated fair values and due to continuing involvement by Nortel and its consolidated subsidiaries with the EMEA Subsidiaries, including NNL's guarantee of the U.K. pension liability, see note 14, Nortel concluded that the initial carrying value of its investment in these consolidated financial statements should reflect the EMEA Subsidiaries' net liabilities, and no gain or loss was recognized on the change to equity accounting. As of May 31, 2010, Nortel concluded that it no longer exercised significant influence over the operating and financial policies of the EMEA Subsidiaries due to the significance of the completed dispositions, the ongoing role and decision making authority of the U.K. Administrators (as defined below), and because Nortel was no longer committed to provide further support to the EMEA Subsidiaries. Accordingly, a loss on deconsolidation was recognized during the year ended December 31, 2010.

Further, based on its review of the applicable accounting guidance, Nortel determined that it did not exercise all of the elements of control over the U.S. Subsidiaries as of October 1, 2010 due to the progression of the Creditor Protection Proceedings, nor did it exercise significant influence over their operating and financial policies. As a result, Nortel also deconsolidated the U.S. Subsidiaries and has accounted for its investment using the cost method of accounting as of October 1, 2010 on a prospective basis. As a result, the financial position and results of operations of the U.S. Subsidiaries are not reflected in its consolidated financial results after September 30, 2010. This change was largely based on Nortel's work toward standalone debtor estates due to the diminishing interdependency between the estates primarily resulting from the sale of substantially all of its global businesses, the increased influence of and participation by the U.S. Principal Officer, as defined below, and the change in composition of the board of directors related to the U.S. Subsidiaries. The change in accounting in respect of these subsidiaries resulted in a non-cash charge of $2,163 in the fourth quarter of 2010. The charge is primarily related to the recognition of intercompany liabilities between the Canadian estate and the U.S. estate, including the guarantee of a U.S. subsidiary's debt as discussed in note 14.

Nortel continues to exercise control over its subsidiaries located in Canada, Central America and Latin America ("CALA") and Asia (other than those entities that are EMEA Subsidiaries, U.S. Subsidiaries or have been placed in liquidation proceedings), and its financial statements are prepared on a consolidated basis with respect to those subsidiaries. Nortel will continue to evaluate its remaining consolidated subsidiaries for the appropriateness of the accounting applied to these investments as the Creditor Protection Proceedings progress.

Basis of Presentation and Going Concern Considerations

The consolidated financial statements include all information and notes required by U.S. Generally Accepted Accounting Principles ("U.S. GAAP") in the preparation of annual consolidated financial statements. Although Nortel is headquartered in Canada, the consolidated financial statements are expressed in U.S. Dollars as the greater part of Nortel's financial results and net assets are denominated in U.S. Dollars.

Nortel makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates. Estimates are used when accounting for items and matters such as revenue recognition and accruals for losses on contracts, allowances for uncollectible accounts and other receivables, recognition and measurement of creditors' claims, fair value of guarantees, allocation of proceeds from sale of businesses and assets (see note 2 – Divestiture Proceeds Received), asset valuations, impairment assessments, employee benefits including pensions, taxes and related valuation allowances and provisions, restructuring and other provisions, contingencies and pre-petition liabilities.

Beginning on January 14, 2009 (the Petition Date), Nortel and certain of its subsidiaries in Canada, the U.S., and in certain EMEA countries filed for creditor protection under the relevant jurisdictions of Canada, the U.S., the United Kingdom ("U.K.") and subsequently commenced separate proceedings in Israel, followed by secondary proceedings in France. The consolidated financial statements do not purport to reflect or provide for the consequences of the Creditor Protection Proceedings. In particular, such consolidated financial statements do not purport to show: (a) as to assets, their realizable value on a liquidation basis or their availability to satisfy liabilities; (b) as to pre-petition liabilities, all amounts that may be allowed for claims or contingencies, or the status and priority thereof, or the amounts at which they may ultimately be settled; (c) as to shareholders' accounts, the effect of any changes that may be made in Nortel's capitalization; or (d) as to divestiture proceeds held in escrow and recorded by NNL solely for financial reporting purposes, the final allocation of these proceeds as between various Nortel legal entities, including entities that are not consolidated in these consolidated financial statements, which will ultimately be determined either by joint agreement or through a dispute resolution proceeding (see note 2).

The ongoing Creditor Protection Proceedings and completed divestitures of Nortel's businesses and assets, both completed and those asset sales that may arise in the future, raise substantial doubt as to whether Nortel will be able to continue as a going concern. While the Debtors (as defined in note 2) have filed for and been granted creditor protection, the consolidated financial statements continue to be prepared using the going concern basis, which assmes that Nortel will be able to realize its assets and discharge its liabilities in the normal course of business for the foreseeable future. However, it is not possible to predict the outcome of the Creditor Protection Proceedings and, as such, there is substantial doubt regarding the realization of assets and discharge of liabilities. If the going concern basis is not appropriate, adjustments will be necessary to the carrying amounts and/or classification of Nortel's assets and liabilities. Further, a court approved plan in connection with the Creditor Protection Proceedings could materially change the carrying amounts and classifications reported in the consolidated financial statements. Nortel will continue to evaluate its remaining consolidated subsidiaries for the appropriateness of the accounting applied to these investments as the Creditor Protection Proceedings progress.

Liquidation of Subsidiaries

With the completed sales of Nortel's businesses, Nortel is focused on maximizing proceeds and cash flows with respect to remaining assets. This includes the winding up of Nortel's remaining operations and subsidiaries globally, which may involve orderly wind-ups as well as commencement of liquidation proceedings, as the circumstances warrant.

Events may impact when, and if, an entity is deemed to be in liquidation including local statutory requirements and court approvals. As such approvals and events occur, Nortel will evaluate whether a change in basis of accounting for such entities is appropriate, and in all such cases, Nortel will assess the carrying values of those entities' assets when it appears likely such entities will be approved for liquidation. Generally, Nortel expects that an entity deemed to be in liquidation will result in a loss of control, deconsolidation of the entity, and accounting for the entity prospectively on a cost method basis. Nortel recorded a loss of $74 for the year ended December 31, 2010, related to the liquidation of seven entities, which are included in reorganization items. No additional entities were deemed to be in liquidation in the year ended December 31, 2011.

Correction of Immaterial Errors Related to Prior Periods

As previously reported, in the course of preparing its interim financial statements for the three months ended March 31, 2011, Nortel became aware of certain NNL contractual guarantees provided in connection with real estate leases entered into by certain EMEA Subsidiaries and U.S. Subsidiaries that were not recognized at fair value upon the respective deconsolidation dates of these subsidiaries.

Nortel was required to establish a fair value at the initial recognition and measurement date for these guarantees under ASC 460 Guarantees ("ASC 460"), which, based on the nature of these guarantees, is the deconsolidation date. These fair values are not determinative of any expected allowed claim under the Creditor Protection Proceedings. See note 14.

These errors resulted in the understatement of Nortel's net loss and liabilities subject to compromise in the second and fourth quarters of 2010 of $68 and $57, respectively, and an understatement of net loss and liabilities subject to compromise of $125 as at and for the year ended December 31, 2010. Nortel has recast the cumulative effect of these errors as at December 31, 2010 by increasing its liabilities subject to compromise and accumulated deficit by $125. Nortel has also recast the statements of operations and cash flows for the year ended December 31, 2010, resulting in a charge to reorganization items, net and a corresponding increase in the net loss reported.

Nortel reviewed the impact of these errors on prior annual and interim periods in accordance with Staff Accounting Bulletin ("SAB") No. 99, Materiality ("SAB 99") and SAB No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements ("SAB 108") and determined that the errors were not material to the applicable prior periods.

The following table summarizes the adjustments to the impacted periods:


	Three Months Ended June 30, 2010		Six Months Ended June 30, 2010		Three Months Ended December 31, 2010		Year Ended December 31, 2010
Reported net loss		($1,504)		($1,149)		($2,277)		($4,075)
Adjustment for the recognition of lease guarantees		($68)		($68)		($57)		($125)

Adjusted net loss		($1,572)		($1,217)		($2,334)		($4,200)

The adjustment totaling $68 for the six months ended June 30, 2010 was also applicable to the nine months ended September 30, 2010 and the comparative period financial results were adjusted accordingly.

Comparative Figures

Certain 2010 figures in the consolidated financial statements have been reclassified to conform to Nortel's current period presentation.