Alcoa 2009 Annual Report Download - page 91

various process residuals, solid wastes, electronic equipment waste, and various other materials. Such amounts may be
material to the Consolidated Financial Statements in the period in which they are recorded.
Income Taxes. The provision for income taxes is determined using the asset and liability approach of accounting for
income taxes. Under this approach, the provision for income taxes represents income taxes paid or payable (or received
or receivable) for the current year plus the change in deferred taxes during the year. Deferred taxes represent the future
tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid, and result
from differences between the financial and tax bases of Alcoa’s assets and liabilities and are adjusted for changes in tax
rates and tax laws when enacted. Valuation allowances are recorded to reduce deferred tax assets when it is more likely
than not that a tax benefit will not be realized. Deferred tax assets for which no valuation allowance is recorded may
not be realized upon changes in facts and circumstances. Tax benefits related to uncertain tax positions taken or
expected to be taken on a tax return are recorded when such benefits meet a more likely than not threshold. Otherwise,
these tax benefits are recorded when a tax position has been effectively settled, which means that the statute of
limitation has expired or the appropriate taxing authority has completed their examination even though the statute of
limitations remains open. Interest and penalties related to uncertain tax positions are recognized as part of the provision
for income taxes and are accrued beginning in the period that such interest and penalties would be applicable under
relevant tax law until such time that the related tax benefits are recognized.
Stock-Based Compensation. Alcoa recognizes compensation expense for employee equity grants using the
non-substantive vesting period approach, in which the expense (net of estimated forfeitures) is recognized ratably over
the requisite service period based on the grant date fair value. The fair value of new stock options is estimated on the
date of grant using a lattice-pricing model. Determining the fair value of stock options at the grant date requires
judgment, including estimates for the average risk-free interest rate, dividend yield, volatility, annual forfeiture rate,
and exercise behavior. These assumptions may differ significantly between grant dates because of changes in the actual
results of these inputs that occur over time.
As part of Alcoa’s stock-based compensation plan design, individuals who are retirement-eligible have a six-month
requisite service period in the year of grant. Equity grants are issued in January each year. As a result, a larger portion
of expense will be recognized in the first and second quarters of each year for these retirement-eligible employees.
Compensation expense recorded in 2009, 2008, and 2007 was $87 ($58 after-tax), $94 ($63 after-tax), and $97 ($63
after-tax), respectively. Of this amount, $21, $19, and $19 in 2009, 2008, and 2007, respectively, pertains to the
acceleration of expense related to retirement-eligible employees.
On December 31, 2005, Alcoa accelerated the vesting of 11 million unvested stock options granted to employees in
2004 and on January 13, 2005. The 2004 and 2005 accelerated options had weighted average exercise prices of $35.60
and $29.54, respectively, and in the aggregate represented approximately 12% of Alcoa’s total outstanding options.
The decision to accelerate the vesting of the 2004 and 2005 options was made primarily to avoid recognizing the
related compensation expense in future earnings upon the adoption of a new accounting standard. The accelerated
vesting of the 2004 and 2005 stock options reduced Alcoa’s after-tax stock option compensation expense in 2007
by $7.
Plan participants can choose whether to receive their award in the form of stock options, stock awards, or a
combination of both. This choice is made before the grant is issued and is irrevocable.
Derivatives and Hedging. Derivatives are held for purposes other than trading and are part of a formally documented
risk management program. For derivatives designated as fair value hedges, Alcoa measures hedge effectiveness by
formally assessing, at least quarterly, the historical high correlation of changes in the fair value of the hedged item and
the derivative hedging instrument. For derivatives designated as cash flow hedges, Alcoa measures hedge effectiveness
by formally assessing, at least quarterly, the probable high correlation of the expected future cash flows of the hedged
item and the derivative hedging instrument. The ineffective portions of both types of hedges are recorded in sales or
other income or expense in the current period. If the hedging relationship ceases to be highly effective or it becomes
probable that an expected transaction will no longer occur, future gains or losses on the derivative are recorded in other
income or expense.
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