Alcoa 2012 Annual Report Download - page 84

derivatives and hedging activities; environmental and litigation matters; asset retirement obligations; the testing of
goodwill, equity investments, and properties, plants, and equipment for impairment; estimating fair value of businesses
to be divested; pension plans and other postretirement benefits obligations; stock-based compensation; and income
taxes.
Management uses historical experience and all available information to make these judgments, estimates, and
assumptions, and actual results may differ from those used to prepare the Company’s Consolidated Financial
Statements at any given time. Despite these inherent limitations, management believes that Management’s Discussion
and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and
accompanying Notes provide a meaningful and fair perspective of the Company.
A summary of the Company’s significant accounting policies is included in Note A to the Consolidated Financial
Statements in Part II Item 8 of this Form 10-K. Management believes that the application of these policies on a
consistent basis enables the Company to provide the users of the Consolidated Financial Statements with useful and
reliable information about the Company’s operating results and financial condition.
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 instrument are
recorded in other income or expense.
Alcoa accounts for interest rate swaps related to its existing long-term debt and hedges of firm customer commitments
for aluminum as fair value hedges. As a result, the fair values of the derivatives and changes in the fair values of the
underlying hedged items are reported in other current and noncurrent assets and liabilities in the Consolidated Balance
Sheet. Changes in the fair values of these derivatives and underlying hedged items generally offset and are recorded
each period in sales or interest expense, consistent with the underlying hedged item.
Alcoa accounts for hedges of foreign currency exposures and certain forecasted transactions as cash flow hedges. The
fair values of the derivatives are recorded in other current and noncurrent assets and liabilities in the Consolidated
Balance Sheet. The effective portions of the changes in the fair values of these derivatives are recorded in other
comprehensive income and are reclassified to sales, cost of goods sold, or other income or expense in the period in
which earnings are impacted by the hedged items or in the period that the transaction no longer qualifies as a cash flow
hedge. These contracts cover the same periods as known or expected exposures, generally not exceeding five years.
If no hedging relationship is designated, the derivative is marked to market through earnings.
Cash flows from derivatives are recognized in the Statement of Consolidated Cash Flows in a manner consistent with
the underlying transactions.
Environmental Matters. Expenditures for current operations are expensed or capitalized, as appropriate. Expenditures
relating to existing conditions caused by past operations, which will not contribute to future revenues, are expensed.
Liabilities are recorded when remediation costs are probable and can be reasonably estimated. The liability may
include costs such as site investigations, consultant fees, feasibility studies, outside contractors, and monitoring
expenses. Estimates are generally not discounted or reduced by potential claims for recovery. Claims for recovery are
recognized as agreements are reached with third parties. The estimates also include costs related to other potentially
responsible parties to the extent that Alcoa has reason to believe such parties will not fully pay their proportionate
share. The liability is continuously reviewed and adjusted to reflect current remediation progress, prospective estimates
of required activity, and other factors that may be relevant, including changes in technology or regulations.
73