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 in Canada, 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. 

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. Alcoa adopted SFAS No. 144, ‘‘Accounting for the Impairment or Disposal of Long-Lived Assets,’’ effective January 1, 2002. 

This standard establishes accounting and reporting require- ments for the impairment or disposal of long-lived assets. 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, earnings multiples, or indicative bids, when available. A number of significant estimates and assumptions are involved in the application 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 experi- ence 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 financial statements. 

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 Consoli- dated Balance Sheet and to discontinued operations in the Statement of Consolidated Income for all periods presented. The Statement of Consolidated Cash Flows is also reclassified for assets held for sale and discontinued operations for all periods presented. Additionally, segment information does not include the 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 disposed of within one year. 

For businesses classified as assets held for sale, the balance sheet and cash flow amounts are reclassified from their historical presentation 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 segment results include the 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 ongoing aluminum or other significant supply contracts. 

Recently Issued Accounting Standards. SFAS No. 123 (revised 2004) ‘‘Share-Based Payment’’ was issued in December 2004. This standard requires companies to measure and recog- nize the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value. The effective date is the first interim reporting period beginning after June 15, 2005. Alcoa is currently evaluating pricing models and the transition provisions of this standard and will begin expensing stock options in the third quarter of 2005. 

In November 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 151, ‘‘Inventory Costs – an Amendment of ARB No. 43, Chapter 4.’’ This standard provides clarification that abnormal amounts of idle facility expense, freight, handling costs, and spoilage should be recognized as current-period charges. Additionally, this standard requires that allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. The provisions of this standard are effective for inventory costs incurred during fiscal years beginning after June 15, 2005. This standard does not have a material impact to Alcoa’s financial statements. 

Reclassification. Certain amounts in previously issued financial statements were reclassified to conform to 2004 presentations. See Note B for further information. 

## B. Discontinued Operations and Assets Held for Sale 

Alcoa’s financial statements for all periods presented were significantly impacted by activities relating to the planned divestiture of a number of Alcoa’s businesses. 

In 2002, Alcoa performed a portfolio review of its businesses and the markets they serve. As a result of this review, Alcoa committed to a plan to divest certain noncore businesses that did not meet internal growth and return measures. This plan was substantially completed in 2004 with the divestitures of the following businesses: specialty chemicals, packaging equipment, automotive fasteners, South American flexible packaging, foil facilities in Russellville, AR and St. Louis, MO, and extrusion facilities in Europe and Brazil. See Note F for additional details. 

In the second quarter of 2004, certain architectural products businesses in North America were reclassified from assets held for sale to assets held and used as management discontinued the plan of sale due to market conditions. The financial state- ments for prior periods have been reclassified to reflect this change. The reclassification did not impact the Statement of Consolidated Income, and the results of operations of these architectural products businesses continue to be presented in the Engineered Products segment. 

Also in 2004, Alcoa identified additional businesses to be divested so as to better focus on its core capabilities. As a result, the following businesses have been reclassified from assets held 

