This a great idea! It's needed and requested so much.
I haven't played FF7 in years, and recently I got it for the PC and added all these awesome mods, I've been playing it, but after playing more recent RPGs that had a good translation, I noticed that the dialogue in FF7 is just horrendous. There's so much that just doesn't make any sense at all. To this day I don't understand the whole Cloud, Zack, Sephiroth cloning stuff (I guess it's all up to interpretation, but the poor translation doesn't help at all.)
Here's some things I can recommend while doing this project.
-Instead of basing the retranslation around the original english version, try to find a script of the original Japanese version straight foward translated into english. If that's not available, maybe find someone who understands Japanese well and have him help, and if you can't find someone to that, then maybe translate it using google translate or something (It would be a long procress, but in my opinion I think it would be much better.)
-Read up on how people feel the characters are. Advent Children presents the characters in a very developed form, and they don't stray too far from the way they present themselves as they do in the English version of the game. (Like sometimes Cloud will be a smartass who thinks he's really tough, then he will be dark and secretive, then he will be a ambiguous leader. I mean, I can understand slight variations of emotions, but they vary so much in the original version it's hard to tell which way a character is. Another example would be Vincent, he's depressed and dark, then he'll make a really awkward joke that doesn't make sense.) I mean, some people like the way the characters present themselves in the game, mostly for nostalgic anime purposes,I presume. (Old anime was always this way, y'know, because it had poor translations in most cases.) So like, maybe you could set up the characters, and completely re-design their presence and demeanor before writing new dialogue.
-Uncensor the cursing! XD
If you need any help writing natural dialogue, lemme know, I've always been interested in doing something like this.