Alcoa 1998 Annual Report Download - page 45

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Notes to Consolidated Financial Statements
(dollars in millions, except share amounts)
A. Summary of Significant Accounting Policies
Principles of Consolidation. The consolidated financial statements
include the accounts of Alcoa and companies more than 50% owned.
Investments in other entities are accounted for principally on an
equity basis.
The consolidated financial statements are prepared in conformity
with generally accepted accounting principles and require manage-
ment to make certain estimates and assumptions. These may affect
the reported amounts of assets and liabilities and the disclosure of
contingent assets and liabilities at the date of the financial state-
ments. They may also affect the reported amounts of revenues and
expenses during the reporting period. Actual results could differ
from those estimates upon subsequent resolution of identified
matters.
Inventory Valuation. Inventories are carried at the lower of cost
or market, with cost for a substantial portion of U.S. and Canadian
inventories determined under the last-in, first-out
(LIFO) method.
The cost of other inventories is principally determined under the
average-cost method. See Note E for additional detail.
Amortization of Intangibles. Theexcesspurchasepriceover
the net tangible assets of businesses acquired is reported as good-
will in the consolidated balance sheet. Goodwill and other intangibles
areamortizedonastraight-linebasisovernotmorethan40years.
The carrying value of goodwill and other intangibles is evaluated
periodically in relation to the operating performance and future
undiscounted cash flows of the underlying businesses. Adjustments
are made if the sum of expected future net cash flows is less than
book value. See Note H for additional information.
Environmental Expenditures. Expenditures for current opera-
tions are expensed or capitalized, as appropriate. Expenditures
relating to existing conditions caused by past operations, and which
do not contribute to future revenues, are expensed. Liabilities are
recorded when remedial efforts are probable and the costs can be
reasonably estimated. The liability may include costs such as site
investigations, consultant fees, feasibility studies, outside contractor
and monitoring expenses. Estimates are not discounted or reduced
by potential claims for recovery. Claims for recovery are recognized
when received. 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 periodically reviewed and adjusted to reflect current
remediation progress, prospective estimates of required activity
and other factors that may be relevant, including changes in tech-
nology or regulations. See Note U for additional information.
Financial Instruments and Commodity Contracts. Alcoa
enters into long-term contracts to supply fabricated products to
a number of its customers. To hedge the market risk of changing
prices for purchases or sales of metal, Alcoa uses commodity
futures and options contracts.
Gains and losses related to transactions that qualify for hedge
accounting, including closed futures contracts, are deferred and
reflected in cost of goods sold when the underlying physical trans-
action takes place. The deferred gains or losses are reflected on
the balance sheet in other current and noncurrent liabilities or
assets. If future purchased metal needs are revised lower than
initially anticipated, the futures contracts associated with the
reduction no longer qualify for deferral and are marked-to-market.
Mark-to-market gains and losses are recorded in other income in
the current period.
The effectiveness of the hedge is measured by a historical and
probable future high correlation of changes in the fair value of the
hedging instruments with changes in value of the hedged item. If
correlation ceases to exist, hedge accounting will be terminated and
gains or losses recorded in other income. To date, high correlation
has always been achieved.
Alcoa also enters into futures and options contracts that cover
long-term, fixed-price commitments to supply customers with metal
from internal sources. These contracts are marked-to-market, and
the gains and losses from changes in market value of the contracts
are recorded in other income in the current period. This resulted
in after-tax losses of $44.5 in 1998, $12.7 in 1997 and $57.1 in 1996.
Alcoa also attempts to maintain a reasonable balance between
fixed- and floating-rate debt, using interest rate swaps and caps,
to keep financing costs as low as possible. If the requirements for
hedge accounting are met, amounts paid or received under these
agreements are recognized over the life of the agreements as
adjustments to interest expense. Otherwise, the instruments are
marked-to-market, and the gains and losses from changes in the
market value of the contracts are recorded in other income in the
current period.
Upon early termination of an interest rate swap or cap, gains
or losses are deferred and amortized as adjustments to interest
expense of the related debt over the remaining period covered by
the terminated swap or cap.
Alcoa is subject to exposure from fluctuations in foreign
currencies. To manage this exposure, Alcoa uses foreign exchange
contracts. Gains and losses on contracts that meet the requirements
for hedge accounting are deferred and included in the basis of the
underlying transactions. Contracts that do not meet these require-
ments are marked-to-market in other income each period.
Cash flows from financial instruments are recognized in the
statement of cash flows in a manner consistent with the underlying
transactions. See Note T for additional detail.
Properties, Plants and Equipment. Properties, plants and
equipment are recorded at cost. Depreciation is recorded principally
onthestraight-linemethodatratesbasedontheestimateduseful
lives of the assets, averaging 33 years for structures and between
five and 25 years for machinery and equipment. Profits or losses
from the sale of assets are included in other income. Repairs and
maintenance are charged to expense as incurred. Interest related
to the construction of qualifying assets is capitalized as part of
the construction costs.
Depletion is taken over the periods during which the estimated
mineral reserves are extracted. See Notes F and S for additional
detail.