Alcoa 2003 Annual Report Download - page 40

and Results of Operations (MD&A) and the financial statements
and related footnotes provide a meaningful and fair perspective
of the company. A discussion of the judgments and uncertainties
associated with accounting for derivatives and environmental
matters can be found in the Market Risks and Environmental
Matters sections of
MD&A .
Asummaryofthe company’s significant accounting policies
is included in Note A to the Consolidated Financial Statements.
Management believes that the application of these policies on a
consistent basis enables the company to provide the users of the
financial statements with useful and reliable information about
the company’s operating results and financial condition.
In 2002, Alcoa adopted the new standard of accounting for
goodwill and intangible assets with indefinite lives. The cumulative
effect adjustment recognized on January 1, 2002, upon adoption
of the new standard, was income of $34 (after tax). Also in 2002,
amortization ceased for goodwill and intangible assets with indefinite
lives. Amortization expense recognized in the Consolidated Income
Statement was $171 in 2001. Additionally, goodwill and indefinite-
lived intangibles are required to be tested for impairment at least
annually. The evaluation of impairment involves comparing the
current fair value of the business to the recorded value (including
goodwill). The company usesadiscounted cash flow model
(
DCF model) to determine the current fair value of the business.
Anumberofsignificant assumptions and estimates are involved
in the application of the DCF model to forecast operating cash
flows, including markets and market share, sales volumes and
prices, costs to produce, and working capital changes. Management
considers historical experience and all available information at
the time the fair values of its businesses are estimated. However,
actual fair values that could be realized in an actual transaction
may differ from those used to evaluate the impairment of goodwill.
In the fourth quarter of 2002, Alcoa committed to a plan to
divest certain noncore businesses that did not meet internal growth
and return measures. The fair values of all businesses to be divested
are estimated using acceptedvaluation techniques such as a
DCF
model, earnings multiples, or indicative bids, when available. A
number of significant estimates and assumptions are involved in the
application of these techniques, including the forecasting of markets
and market share, sales volumes and prices, costs and expenses, and
multiple other factors. Management considers historical experience
and all available information at the time the estimates are made;
however, the fair values that are ultimately realized upon the sale
of the businesses to be divested may differ from the estimated fair
values reflected in the financial statements.
Other areas of significant judgments and estimates include the
liabilities and expenses for pensions and other postretirement
benefits. These amounts are determined using actuarial method-
ologies and incorporate significant assumptions, including the rate
used to discount thefuture estimated liability, the long-term rate
of return on plan assets, and several assumptions relating to the
employeeworkforce (salary increases, medical costs, retirement age,
andmortality). The rate used to discount future estimated liabilities
is determined considering the rates available at year-end on debt
38
instruments that could be used to settle the obligations of the plan.
Theimpactonthe liabilities of a change in the discount rate of
1
⁄
4
of
1% is approximately $335 and a change of $14 to after-tax earnings
in the following year. The long-term rate of return is estimated by
considering historical returns and expected returns on current and
projected asset allocations and is generally applied to a five-year
average market value of assets. A change in the assumption for the
long-term rate of return on plan assets of
1
⁄
4
of 1% would impact
after-tax earnings by approximately $12 for 2004.
In 2002,the declines in equity markets and interest rates had a
negative impact on Alcoa’s pension plan liability and fair value of
plan assets.Asaresult, the accumulated benefit obligation exceeded
the fair value of plan assets at the end of 2002, which resulted in a
netchargeof$851toshareholders’ equity. In 2003, a net charge of
$39was recorded in shareholders’ equity as strong asset returns of
19.75% almostentirelyoffset higher accumulated benefit obligations
resulting from a 50 basis point decline in the discount rate.
As aglobal company, Alcoa records an estimated liability for
income and other taxes based on what it determines will likely be
paid in the various tax jurisdictions in which it operates. Manage-
ment uses its best judgment in the determination of these amounts.
However, the liabilities ultimately realized and paid are dependent
on various matters including the resolution of the tax audits in the
various affected tax jurisdictionsandmaydiffer from the amounts
recorded. An adjustment to the estimated liability would be recorded
through income in the period in which it becomes probable that
theamount of the actual liability differs from the amount recorded.
Related Party Transactions
Alcoa buys products from and sells products to various related
companies, consisting of entities in which Alcoa retains a 50% or
less equity interest, at negotiated prices between thetwoparties.
These transactions were not material to the financial position or
results of operations of Alcoa at December 31, 2003.
Recently Issued and Adopted
Accounting Standards
Effective December 31,2003,Alcoa adopted SFAS No. 132 (revised
2003), ‘‘Employers’ Disclosures about Pensions and Other Post-
retirement Benefits – an amendment of FASB Statements No. 87, 8 8,
and 106.’’ This standard requires additional disclosures about an
employer’spension plans andpostretirementbenefit plans such as:
the types of plan assets, investment strategy, measurement date,
plan obligations, cash flows, and components of net periodic benefit
cost recognized during interim periods. See Note V to the Consoli-
dated Financial Statements for the required additional disclosures.
Effective December 31, 2003, Alcoa adopted Financial Account-
ing Standards Board
(FASB) Interpretation No. 46 (revised December
2003), ‘‘Consolidation of Variable Interest Entities – an Interpretation
of ARB51.’’ Interpretation No. 46 addresses consolidation and
disclosure by business enterprises of variable interest entities. This
standard has no impact on Alcoa’s financial statements.