How does the fault system work with AppleCare warranty extension?

I'm an owner of an iPhone 4S on Telus Mobility in Canada and I have two year AppleCare warranty extension that is linked to my phone. I've had my iPhone for over a year now with no issues, so this question is meant for reference if and when I do need to make a claim.
When I bought my AppleCare, the representative never explained to me how the fault system works, or if and what I pay in the event of a claim, or really anything else related to AppleCare. My friend told me if I pay a certain amount of money during a claim, I can get a new iPhone. Is this true? Are there limitations of the AppleCare?
Could somebody please explain to me in a fairly decent amount of detail how AppleCare works, how the fault system works, and anything else I would need to know about AppleCare? Thanks.

Here's the link explaining it:
http://www.apple.com/support/products/iphone.html
This would work in the U.S. - I think (but am not sure) it will work in Canada as well.

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How does the fault system work with AppleCare warranty extension?

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