Alcoa 2004 Annual Report Download - page 47

Notes to the Consolidated
Financial Statements
(dollars in millions, except per-share amounts)
A. Summary of Significant Accounting Policies
Basis of Presentation. The Consolidated Financial Statements
are prepared in conformity with accounting principles generally
accepted in the United States of America 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 statements. They also may 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.
Principles of Consolidation. The Consolidated Financial
Statements include the accounts of Alcoa and companies
more than fifty percent owned. Intercompany transactions
have been eliminated. Investments in affiliates and other
joint ventures in which Alcoa has a noncontrolling ownership
interest between twenty and fifty percent are accounted
for on the equity method. Investments in affiliates in which
Alcoa has an ownership interest less than twenty percent are
accounted for on the cost method.
Alcoa also evaluates consolidation of entities under Financial
Accounting Standards Board Interpretation No. 46, ‘‘Consoli-
dation of Variable Interest Entities’’ ( FIN 46). FIN 46 requires
management to evaluate whether an entity is a variable interest
entity and whether Alcoa is the primary beneficiary. Consolida-
tion is required if both of these criteria are met. Alcoa does
not have any variable interest entities requiring consolidation.
Cash Equivalents. Cash equivalents are highly liquid
investments purchased with an original maturity of three
months or less.
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 G for
additional information.
Properties, Plants, and Equipment. Properties, plants,
and equipment are recorded at cost. Depreciation is recorded
principally on the straight-line method at rates based on the
estimated useful lives of the assets, averaging 33 years for struc-
tures and approximately 16 years for machinery and equipment,
as useful lives range between 5 and 25 years. Gains 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 H and V for additional information.
Goodwill and Other Intangible Assets. Alcoa adopted
Statement of Financial Accounting Standards (SFAS) No. 142,
‘‘Goodwill and Other Intangible Assets,’’ effective January 1,
2002. Under this standard, goodwill and intangibles with
indefinite useful lives are no longer amortized. Intangible assets
45
with finite useful lives are amortized generally on a straight-
line basis over the periods benefited, with a weighted average
useful life of 13 years.
The carrying values of goodwill and other intangible assets
with indefinite useful lives are tested at least annually for
impairment. If the carrying value of goodwill or an intangible
asset exceeds its fair value, an impairment loss is recognized.
The evaluation of impairment involves comparing the current
fair value of the business to the recorded value (including
goodwill). The company uses a discounted cash flow model
(
DCF model) to determine the current fair value of the business.
A number of significant 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. Manage-
ment considers historical experience and all available informa-
tion 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 impair-
ment of goodwill. See Note E for additional information.
Accounts Payable Arrangements. Alcoa participates
in computerized payable settlement arrangements with
certain vendors and third-party intermediaries. The arrange-
ments provide that, at the vendor’s request, the third-party
intermediary advances the amount of the scheduled payment
to the vendor, less an appropriate discount, before the sched-
uled payment date. Alcoa makes payment to the third-party
intermediary on the date stipulated in accordance with the
commercial terms negotiated with its vendors. The amounts
outstanding under these arrangements that will be paid
through the third-party intermediaries have been classified
as short-term borrowings in the Consolidated Balance Sheet
at December 31, 2004 and as cash provided from financing
activities in the Statement of Consolidated Cash Flows at
December 31, 2004. See Note K for additional information.
Revenue Recognition. Alcoa recognizes revenue when title,
ownership, and risk of loss pass to the customer, in accordance
with the provisions of Staff Accounting Bulletin 104, ‘‘Revenue
Recognition in Financial Statements.’’
Alcoa periodically enters into long-term supply contracts
with alumina and aluminum customers and receives advance
payments for product to be delivered in future periods.
These advance payments are recorded as deferred revenue,
and revenue is recognized as shipments are made and title,
ownership, and risk of loss pass to the customer during the
term of the contracts.
Environmental Expenditures. Expenditures for current
operations 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 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