Dare I admit I've rather clueless when it comes to linux, beyond installing a ubuntu liveCD I have no experience but I am aware that it might be what I'm looking for.
I'd like to find a simpler operating system for my grandparents laptop, currently an Acer running Windows XP, firstly is this choice of hardware going to be a problem?
I wouldn't say that Linux is necessarily simpler than any other OS... it does some things differently, and some things better in my opinion, than Windows does them, but I wouldn't go so far as to say it's simpler. However, it's not any more difficult than other OSes to use either
As for the hardware question... dunno - what hardware does the laptop run? Generally, the less bleeding-edge hardware the better your chances are that someone has made drivers if none are officially available from the vendor.
These are the features I'm looking for:
Very simple interface but still appear "pretty"
The ability to use large fonts and icons
Ability to work with dial-up internet
I would suggest any of the popular distros... however, I'd suggest looking at KDE rather than Gnome or xfce, etc... In case you're not familiar with these things, KDE (and Gnome) is a desktop environment. Whereas in Windows, you've got the choice of using the bog standard Windows desktop environment or er... not using Windows, in Linux the desktop environment is separate from the kernel and you are free (and encouraged) to use whatever you feel more comfortable using.
I personally find KDE more "eye candy"-ish than Gnome. Gnome is still a good desktop environment, but I find it's more concentrated on being functional than flashy. You'll be surprised at just how much control you have over how you can make KDE look and feel... it's very refreshing
As such, I'd recommend they use the Kubuntu distribution/distro. It's the KDE version of Ubuntu... which ships with Gnome normally (you could just install KDE on a normal Ubuntu, but going with Kubuntu from the start will save you a bit of time and work). I think you'll find the whole Ubuntu (including Kubuntu, Xubuntu (which uses xfce), Edubuntu (an educational-specific distro), etc...) community the best - especially if you're not too familiar with Linux yourself just yet. With the community as large as it is, you're almost guaranteed to find that someone has already encountered any problem you may run into, and will have explained how to resolve it. Check out the
http://www.ubuntuforums.org website to see how huge the community is.
Would be great if it can work with these or similar applications:
Openoffice
Firefox
Thunderbird
Rainlendar
VLC
AV/Firewall if required
All of these programs will run fine under Kubuntu... with the possible exception of Rainlendar - which I had to Google to see what it is

There will be an equivalent for Linux though.
The need for AV and a firewall is different under Linux... you can get by surfing the internet without either of them and not be worried. However, there are products available, e.g. ClamAV and Shorewall.
Slightly more complicated features that would be useful but not mandatory:
Remote desktop functionality so I can fix things from afar
Compatibility with something that will take a drive image so I can backup to a restore in case they get malicious software on the machine.
Remote desktop functionality... yep, built-in. Several different ways of doing this too. FreeNX, VNC, etc...
Backing up the machine in case of malicious software...? It's easily do-able in Linux. However, if you back-up your grandparent's so-called Home directory, you've pretty much covered yourself. You could back that up to a floppy disk or even email it to yourself. No need to back-up the entire drive.
Thinking about this, there are a few different ways you might want to consider doing this (some are slightly more advanced than others but offer more functionality. For example, you could put your home on a different partition during the installation... takes 30 seconds to do but means you can re-install the entire OS and it'll still appear the same for your grandparents - just as if nothing had happened at all.
Saying that, you'll not really need to re-image a drive because of malware... this isn't Windows


Not much to ask eh!
If anyone can suggest which linux distro they'd use or recommend in my position and any known sofware that would help I'd be very grateful.
Cheers
Not much at all. As shown, Linux can handle all this and so much more... and it won't cost you a penny to try it out.
Give Kubuntu a whirl. Have a play with the LiveCD or use Wubi if you're a bit more adventurous. I'm sure you'll see how it could be ideal for your grandparents' needs.