Alcoa 2010 Annual Report Download - page 91

Negative evidence includes items such as cumulative losses, projections of future losses, or carryforward periods that
are not long enough to allow for the utilization of a deferred tax asset based on existing projections of income. Deferred
tax assets for which no valuation allowance is recorded may not be realized upon changes in facts and circumstances.
Tax benefits related to uncertain tax positions taken or expected to be taken on a tax return are recorded when such
benefits meet a more likely than not threshold. Otherwise, these tax benefits are recorded when a tax position has been
effectively settled, which means that the statute of limitation has expired or the appropriate taxing authority has
completed their examination even though the statute of limitations remains open. Interest and penalties related to
uncertain tax positions are recognized as part of the provision for income taxes and are accrued beginning in the period
that such interest and penalties would be applicable under relevant tax law until such time that the related tax benefits
are recognized.
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. The fair value of new stock options is estimated on the
date of grant using a lattice-pricing model. Determining the fair value of stock options at the grant date requires
judgment, including estimates for the average risk-free interest rate, dividend yield, volatility, annual forfeiture rate,
and exercise behavior. These assumptions may differ significantly between grant dates because of changes in the actual
results of these inputs that occur over time.
Plan participants can choose whether to receive their award in the form of stock options, stock awards, or a
combination of both. This choice is made before the grant is issued and is irrevocable.
Derivatives and Hedging. Derivatives are held for purposes other than trading and are part of a formally documented
risk management program. For derivatives designated as fair value hedges, Alcoa measures hedge effectiveness by
formally assessing, at least quarterly, the historical high correlation 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 sales or
other income or expense in the current period. 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.
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 effective portions of the changes in the fair values of these derivatives are recorded in other
comprehensive income and are reclassified to sales, cost of goods sold, or other income or expense 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.
If no hedging relationship is designated, the derivative is marked to market through earnings.
Cash flows from derivatives are recognized in the Statement of Consolidated Cash Flows in a manner consistent with
the underlying transactions.
Foreign Currency. The local currency is the functional currency for Alcoa’s significant operations outside the U.S.,
except for certain operations in Canada, Russia and Iceland, 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.
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