Alcoa 2006 Annual Report Download - page 40

facilities. These AROs consist primarily of costs associated
with spent pot lining disposal, closure of bauxite residue
areas, mine reclamation, and landfill closure. Alcoa also
recognizes AROs for any significant lease restoration obliga-
tion, if required by a lease agreement, and for the disposal
of regulated waste materials related to the demolition of
certain power facilities. The fair values of these AROs are
recorded on a discounted basis, at the time the obligation is
incurred, and accreted over time for the change in present
value. Additionally, Alcoa capitalizes asset retirement costs
by increasing the carrying amount of the related long-lived
assets and depreciating these assets over their remaining
useful life.
Certain conditional asset retirement obligations (CAROs)
related to alumina refineries and aluminum smelters have
not been recorded in the consolidated financial statements
because the fair value of such potential retirement obliga-
tions cannot be reasonably estimated. A CARO is a legal
obligation to perform an asset retirement activity in which
the timing and (or) method of settlement are conditional on
a future event that may or may not be within Alcoa’s con-
trol. The perpetual nature of the refineries and smelters,
maintenance and upgrade programs, and other factors
prevent a reasonable estimation to be made due to
uncertainties surrounding the ultimate settlement date. At
the date a reasonable estimate can be made, Alcoa would
record a retirement obligation for the removal, treatment,
transportation, storage and (or) disposal of various regu-
lated assets and hazardous materials such as asbestos,
underground and aboveground storage tanks, PCBs, 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.
Goodwill and Other Intangible Assets. Goodwill
and indefinite-lived intangible assets are tested annually for
impairment and whenever events or circumstances change,
such as a significant adverse change in business climate or
the decision to sell a business, that would make it more
likely than not that an impairment may have occurred. The
evaluation of impairment involves comparing the current
fair value of each reporting unit to the recorded value,
including goodwill. Alcoa uses a discounted cash flow
model (DCF model) to determine the current fair value of its
reporting units. 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,
discount rate, and working capital changes. Management
considers historical experience and all available information
at the time the fair values of its reporting units are esti-
mated. However, fair values that could be realized in an
actual transaction may differ from those used to evaluate
the impairment of goodwill.
Properties, Plants, and Equipment. Properties,
plants, and equipment are reviewed for impairment when-
ever events or changes in circumstances indicate that the
carrying amount of such assets (asset group) may not be
recoverable. Recoverability of assets is determined by
comparing the estimated undiscounted net cash flows of the
operations to which the assets (asset group) related to their
carrying amount. An impairment loss would be recognized
when the carrying amount of the assets (asset group)
exceeds the estimated undiscounted net cash flows. The
amount of the impairment loss to be recorded is calculated
as the excess of the carrying value of the assets (asset group)
over their fair value, with fair value determined using the
best information available, which generally is a discounted
cash flow analysis.
Discontinued Operations and Assets Held For
Sale. The fair values of all businesses to be divested are
estimated using accepted valuation techniques such as a
DCF model, valuations performed by third parties, 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 consolidated financial statements.
Pension Plans and Other Postretirement
Benefits. Liabilities and expenses for pension plans and
other postretirement benefits are determined using actuarial
methodologies and incorporate significant assumptions,
including the rate used to discount the future estimated
liability, the long-term rate of return on plan assets, and
several assumptions relating to the employee workforce
(salary increases, medical costs, retirement age, and
mortality). The rate used to discount future estimated
liabilities is determined considering the rates available at
year-end on debt instruments that could be used to settle the
obligations of the plan. The impact on the liabilities of a
change in the discount rate of 1/4 of 1% is approximately
$410 and either a charge or credit of $19 to after-tax earn-
ings in the following year. The long-term rate of return on
plan assets 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 $14 for 2007. The 10-year
moving average of actual performance has consistently
exceeded 9% over the past 20 years.
In 2006, a net charge of $1,065 ($693 after-tax) was
recorded in shareholders’ equity comprised of a charge of
$1,353 ($877 after-tax) related to the adoption of Statement
of Financial Accounting Standards (SFAS) No. 158,
“Employers’ Accounting for Defined Benefit Pension and
Other Postretirement Plans-an amendment of FASB State-
ments No. 87, 88, 106 and 132(R),” (SFAS 158), partially
offset by a credit of $288 ($184 after-tax) due to the reduc-
tion in the minimum pension liability, as a result of asset
returns of 11% and a decrease to the accumulated benefit
obligations resulting from a 25 basis point increase in the
discount rate. In 2005, a net charge of $228 ($148 after-tax)
was recorded in shareholders’ equity as asset returns of 8%
were more than offset by higher accumulated benefit obliga-
tions caused by a 30 basis point decline in the discount rate.
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. Determining the fair value of stock options at the
grant date requires judgment including estimates for the
average risk-free interest rate, expected volatility, expected
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