Alcoa 2014 Annual Report Download - page 118

In reviewing goodwill for impairment, an entity has the option to first assess qualitative factors to determine whether
the existence of events or circumstances leads to a determination that it is more likely than not (greater than 50%) that
the estimated fair value of a reporting unit is less than its carrying amount. If an entity elects to perform a qualitative
assessment and determines that an impairment is more likely than not, the entity is then required to perform the
existing two-step quantitative impairment test (described below), otherwise no further analysis is required. An entity
also may elect not to perform the qualitative assessment and, instead, proceed directly to the two-step quantitative
impairment test. The ultimate outcome of the goodwill impairment review for a reporting unit should be the same
whether an entity chooses to perform the qualitative assessment or proceeds directly to the two-step quantitative
impairment test.
Alcoa’s policy for its annual review of goodwill is to perform the qualitative assessment for all reporting units not
subjected directly to the two-step quantitative impairment test. Management will proceed directly to the two-step
quantitative impairment test for a minimum of three reporting units (based on facts and circumstances) during each
annual review of goodwill. This policy will result in each of the eight reporting units with goodwill being subjected to
the two-step quantitative impairment test at least once during every three-year period.
Under the qualitative assessment, various events and circumstances (or factors) that would affect the estimated fair
value of a reporting unit are identified (similar to impairment indicators above). These factors are then classified by the
type of impact they would have on the estimated fair value using positive, neutral, and adverse categories based on
current business conditions. Additionally, an assessment of the level of impact that a particular factor would have on
the estimated fair value is determined using high, medium, and low weighting. Furthermore, management considers the
results of the most recent two-step quantitative impairment test completed for a reporting unit and compares the
weighted average cost of capital (WACC) between the current and prior years for each reporting unit.
During the 2014 annual review of goodwill, management performed the qualitative assessment for five reporting units,
the Global Rolled Products segment and four of the five reporting units in the Engineered Products and Solutions
segment, including AFS and APP. Management concluded that it was not more likely than not that the estimated fair
values of the five reporting units were less than their carrying values. As such, no further analysis was required.
Under the two-step quantitative impairment test, the evaluation of impairment involves comparing the current fair
value of each reporting unit to its carrying value, including goodwill. Alcoa uses a DCF model to estimate the current
fair value of its reporting units when testing for impairment, as management believes forecasted cash flows are the best
indicator of such fair value. 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, production
costs, tax rates, capital spending, discount rate, and working capital changes. Most of these assumptions vary
significantly among the reporting units. Cash flow forecasts are generally based on approved business unit operating
plans for the early years and historical relationships in later years. The betas used in calculating the individual reporting
units’ WACC rate are estimated for each business with the assistance of valuation experts.
In the event the estimated fair value of a reporting unit per the DCF model is less than the carrying value, additional
analysis would be required. The additional analysis would compare the carrying amount of the reporting unit’s
goodwill with the implied fair value of that goodwill, which may involve the use of valuation experts. The implied fair
value of goodwill is the excess of the fair value of the reporting unit over the fair value amounts assigned to all of the
assets and liabilities of that unit as if the reporting unit was acquired in a business combination and the fair value of the
reporting unit represented the purchase price. If the carrying value of goodwill exceeds its implied fair value, an
impairment loss equal to such excess would be recognized, which could significantly and adversely impact reported
results of operations and shareholders’ equity.
During the 2014 annual review of goodwill, management proceeded directly to the two-step quantitative impairment
test for three reporting units as follows: the Alumina segment, SAE, and one of the five reporting units in the
Engineered Products and Solutions segment. The estimated fair values of these three reporting units were substantially
in excess of their respective carrying value, resulting in no impairment.
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