Alcoa 2014 Annual Report Download - page 121

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
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 instrument 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
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