Alcoa 2006 Annual Report Download - page 52

mally assessing, at least quarterly, the historical high correla-
tion 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 revenues or
other income or expense in the current period. A gain of
$10 was recorded in 2006 (gain of $11 in 2005 and a loss
of $18 in 2004) for the ineffective portion of aluminum
hedges. If the hedging relationship ceases to be highly effec-
tive 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. Two interest rate
swaps ceased to qualify as hedges in 2004, due to the
restructuring of debt, and were terminated. See Notes K and
X for additional information. No other hedging transactions
ceased to qualify as hedges in 2006, 2005 or 2004.
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 Con-
solidated 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, con-
sistent 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 accumulated
other comprehensive loss (a loss of $487 and a gain of $37
at December 31, 2006 and 2005, respectively) and are
reclassified to sales, cost of goods sold, or other income 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. Assuming market rates remain constant with the rates
at December 31, 2006, a loss of $113 is expected to be
recognized in earnings over the next 12 months.
If no hedging relationship is designated, the derivative is
marked to market through earnings.
Cash flows from financial instruments are recognized in
the Statement of Consolidated Cash Flows in a manner
consistent with the underlying transactions. See Notes K and
X for additional information.
Foreign Currency. The local currency is the functional
currency for Alcoa’s significant operations outside the U.S.,
except certain operations in Canada, where the U.S. dollar is
used as the functional currency. The determination of the
functional currency for Alcoa’s operations is made based on
the appropriate economic and management indicators.
Acquisitions. Alcoa’s acquisitions are accounted for
using the purchase method. The purchase price is allocated
to the assets acquired and liabilities assumed based on their
estimated fair market values. Any excess purchase price over
the fair market value of the net assets acquired is recorded as
goodwill. For all acquisitions, operating results are included
in the Statement of Consolidated Income since the dates of
the acquisitions. See Note F for additional information.
Discontinued Operations and Assets Held For
Sale. For those businesses where management has
committed to a plan to divest, each business is valued at the
lower of its carrying amount or estimated fair value less cost
to sell. If the carrying amount of the business exceeds its
estimated fair value, a loss is recognized. The fair values 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.
Businesses to be divested are classified in the Con-
solidated Financial Statements as either discontinued
operations or assets held for sale. For businesses classified as
discontinued operations, the balance sheet amounts and
income statement results are reclassified from their historical
presentation to assets and liabilities of operations held for
sale on the Consolidated Balance Sheet and to discontinued
operations in the Statement of Consolidated Income for all
periods presented. The gains or losses associated with these
divested businesses are recorded in income (loss) from
discontinued operations in the Statement of Consolidated
Income. The Statement of Consolidated Cash Flows is also
reclassified for assets held for sale and discontinued oper-
ations for all periods presented. Additionally, segment
information does not include the results of businesses classi-
fied as discontinued operations. Management does not
expect any continuing involvement with these businesses
following the sales, and these businesses are expected to be
disposed of within one year.
For businesses classified as assets held for sale that do not
qualify for discontinued operations treatment, the balance
sheet and cash flow amounts are reclassified from their
historical presentation to assets and liabilities of operations
held for sale. The income statement results continue to be
reported in the historical income statement categories as
income from continuing operations. The gains or losses
associated with these divested businesses are generally
recorded in restructuring and other charges in the Statement
of Consolidated Income. The segment operating results
include the results of businesses classified as assets held for
sale for all periods presented. Management expects that
Alcoa will have continuing involvement with these busi-
nesses following the sale, primarily in the form of equity
participation, or ongoing aluminum or other significant
supply contracts.
Recently Adopted Accounting Standards. Alcoa
adopted Statement of Financial Accounting Standards
(SFAS) No. 158, “Employers’ Accounting for Defined
Benefit Pension and Other Postretirement Plans – an
amendment of FASB Statements No. 87, 88, 106 and
132(R),” (SFAS 158), effective December 31, 2006. The
adoption of SFAS 158 resulted in the following impacts: a
reduction of $119 in existing prepaid pension costs and
intangible assets, the recognition of $1,234 in accrued
pension and postretirement liabilities, and a charge of
$1,353 ($877 after-tax) to accumulated other compre-
hensive loss. See Note W for additional information.
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