Alcoa 2013 Annual Report Download - page 111

as asbestos, underground and aboveground storage tanks, polychlorinated biphenyls (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.
Income Taxes. The provision for income taxes is determined using the asset and liability approach of accounting for
income taxes. Under this approach, the provision for income taxes represents income taxes paid or payable (or received
or receivable) for the current year plus the change in deferred taxes during the year. Deferred taxes represent the future
tax consequences expected to occur when the reported amounts of assets and liabilities are recovered or paid, and result
from differences between the financial and tax bases of Alcoa’s assets and liabilities and are adjusted for changes in tax
rates and tax laws when enacted.
Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will
not be realized. In evaluating the need for a valuation allowance, management considers all potential sources of taxable
income, including income available in carryback periods, future reversals of taxable temporary differences, projections
of taxable income, and income from tax planning strategies, as well as all available positive and negative evidence.
Positive evidence includes factors such as a history of profitable operations, projections of future profitability within
the carryforward period, including from tax planning strategies, and Alcoa’s experience with similar operations.
Existing favorable contracts and the ability to sell products into established markets are additional positive evidence.
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,
resulting in a future charge to establish a valuation allowance. Existing valuation allowances are re-examined under the
same standards of positive and negative evidence. If it is determined that it is more likely than not that a deferred tax
asset will be realized, the appropriate amount of the valuation allowance, if any, is released. Deferred tax assets and
liabilities are also re-measured to reflect changes in underlying tax rates due to law changes and the granting and lapse
of tax holidays.
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.
Most 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
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