I scanned this image at 300dpi and 200%. This allows me to work at (almost) pixel level, so adjustments can be made minutely, and they won't be as obvious.
I copied the background layer and turned the original background layer off. Then I desaturated the image.
I used the polygon lasso tool to select the area around the boy and pasted him onto his own layer. I went back to the previous layer and, using the paint bucket tool, I coloured my blank layer an off white.
On the layer with the little boy, I adjusted contrast and brightness using levels. From there, I used a combination of the healing brush (in Photoshop CS2) and the clone stamp to remove blemishes and mold.
I LOVE the healing brush. I prefer it to the clone tool as it blends the pixels to that of the surrounding pixels in the area you're repairing. Which means that you don't tend to get the patterning that occurs with the clone tool if you're not careful, and any adjustments are subtle. If you alt+click it will select from the area you choose. I find that where there is an obvious difference between one area (say a subjects shirt) you get a "smudged" look. So if you must heal an area like this, alt+click on the border of the undamaged shirt and background (making sure that the area matches the angle of the damaged area) and the problem will be fixed. If you have to restore an area close to your primary subject, and the damage doesn't involve the shirt edge, then I suggest you use the clone tool, so you can get up close to the subject.
Once I was happy with the boy's image, I flattened it to combine the off white background and the little boy. I then used the variations in a combination of red then yellow to obtain the sepia colour of the original photo.
For colouring, I use a brilliant program called Blackmagic. It simplifies the whole process. If you don't have that program, you can still do it in your graphics program.
Say you want to colour the hair, use the lasso tool select the hair only and copy to a separate layer. Then use the magic wand select the background of the hair layer and ctrl+shift+I. This will allow you to paint only the hair. Then make the layer an overlay and adjust the opacity to get the right look. Do the same for other sections you want to colourise. If you have a copy of the original hand coloured print, you can have it open at the same time and select colours from it to use in your new image!