Looking at the cast, it could be that the tale will be told retrospectively - you know, with old Bilbo and Frodo sitting around a table at Bag End or Rivendale (or wherever), looking over the Red Book, probably with Legolas and Galadriel, then fade to The Hobbit... it would certainly help to explain the presence of some of the cast!
As for the actors, I think that Martin Freeman will make an excellent Bilbo. He even looks like a younger version of Ian Holm! I also think that Leonard Nimoy would make a good Smaug. I can already hear him now.