Alcoa 2007 Annual Report Download - page 54

respectively) for the ineffective portion of aluminum hedges. 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 are recorded in other income or
expense. No hedging transactions ceased to qualify as hedges in
2007, 2006 or 2005.
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 effec-
tive portions of the changes in the fair values of these derivatives
are recorded in other comprehensive loss (losses of $565 and $487
at December 31, 2007 and 2006, 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, 2007, a loss of $101 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, Brazil, Russia and Iceland, where
the U.S. dollar is used as the functional currency. The determi-
nation 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, earn-
ings multiples, or indicative bids, when available. A number of
significant estimates and assumptions are involved in the applica-
tion 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.
Depreciation is no longer recorded on assets of businesses to be
divested once they are classified as held for sale.
Businesses to be divested are classified in the Consolidated
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 Con-
solidated Income, respectively, 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 dis-
continued operations for all periods presented. Additionally,
segment information does not include the operating results of
businesses classified as discontinued operations. Management
does not expect any continuing involvement with these businesses
following the sales, and these businesses are expected to be dis-
posed 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 pre-
sentation 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 information
includes the operating results of businesses classified as assets
held for sale for all periods presented. Management expects that
Alcoa will have continuing involvement with these businesses
following the sale, primarily in the form of equity participation, or
ongoing aluminum or other significant supply contracts.
Recently Adopted Accounting Standards. On Jan-
uary 1, 2007, Alcoa adopted FASB Interpretation (FIN) No. 48,
“Accounting for Uncertainty in Income Taxes—an interpretation
of FASB Statement No. 109,” (FIN 48). FIN 48 prescribes a
comprehensive model for how a company should recognize, meas-
ure, present, and disclose in its financial statements, uncertain tax
positions that it has taken or expects to take on a tax return. This
Interpretation requires that a company recognize in its financial
statements the impact of tax positions that meet a "more likely
than not" threshold, based on the technical merits of the position.
The tax benefits recognized in the financial statements from such a
position should be measured based on the largest benefit that has
a greater than fifty percent likelihood of being realized upon
ultimate settlement.
Effective January 1, 2007, Alcoa adopted FASB Staff Position
(FSP) No. FIN 48-1, “Definition of Settlement in FASB Inter-
pretation No. 48,” (FSP FIN 48-1), which was issued on May 2,
2007. FSP FIN 48-1 amends FIN 48 to provide guidance on how
an entity should determine whether a tax position is effectively
settled for the purpose of recognizing previously unrecognized tax
benefits. The term “effectively settled” replaces the term
“ultimately settled” when used to describe recognition, and the
terms “settlement” or “settled” replace the terms “ultimate
settlement” or “ultimately settled” when used to describe
measurement of a tax position under FIN 48. FSP FIN 48-1 clari-
fies that a tax position can be effectively settled upon the
completion of an examination by a taxing authority without being
legally extinguished. For tax positions considered effectively set-
tled, an entity would recognize the full amount of tax benefit, even
if the tax position is not considered more likely than not to be
52