Southwest Airlines 2008 Annual Report Download - page 69

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
The Company is also required to collect certain
taxes and fees from Customers on behalf of
government agencies and remit these back to the
applicable governmental entity on a periodic basis.
These taxes and fees include U.S. federal
transportation taxes, federal security charges, and
airport passenger facility charges. These items are
collected from Customers at the time they purchase
their tickets, but are not included in Passenger
revenue. The Company records a liability upon
collection from the Customer and relieves the
liability when payments are remitted to the applicable
governmental agency.
Frequent flyer program
The Company records a liability for the
estimated incremental cost of providing free travel
under its Rapid Rewards frequent flyer program at
the time an award is earned. The estimated
incremental cost includes direct passenger costs such
as fuel, food, and other operational costs, but does
not include any contribution to overhead or profit.
The Company also sells frequent flyer credits
and related services to companies participating in its
Rapid Rewards frequent flyer program. Funds
received from the sale of flight segment credits are
accounted for under the residual value method. Under
this method, the Company has determined the portion
of funds received for sale of flight segment credits
that relate to free travel, currently estimated at 81
percent of the amount received per flight segment
credit sold. These amounts are deferred and
recognized as “Passenger revenue” when the ultimate
free travel awards are flown or the credits expire
unused. The remaining 19 percent of the amount
received per flight segment credit sold, which is
assumed not to be associated with future travel,
includes items such as access to the Company’s
frequent flyer program population for marketing/
solicitation purposes, use of the Company’s logo on
co-branded credit cards, and other trademarks,
designs, images, etc. of the Company for use in
marketing materials. This remaining portion is
recognized in “Other revenue” in the period earned.
Advertising
The Company expenses the costs of advertising
as incurred. Advertising expense for the years ended
December 31, 2008, 2007, and 2006 was $199
million, $191 million, and $182 million, respectively.
Share-based Employee compensation
The Company has share-based compensation
plans covering the majority of its Employee groups,
including a plan covering the Company’s Board of
Directors and plans related to employment contracts
with the Chairman Emeritus of the Company. The
Company accounts for share-based compensation
utilizing the fair value recognition provisions of
SFAS No. 123R, “Share-Based Payment.” See Note
14.
Financial derivative instruments
The Company accounts for financial derivative
instruments utilizing Statement of Financial
Accounting Standards No. 133 (SFAS 133),
“Accounting for Derivative Instruments and Hedging
Activities,” as amended. The Company utilizes
various derivative instruments, including crude oil,
unleaded gasoline, and heating oil-based derivatives,
to attempt to reduce the risk of its exposure to jet fuel
price increases. These instruments primarily consist
of purchased call options, collar structures, and fixed-
price swap agreements, and upon proper qualification
are accounted for as cash-flow hedges, as defined by
SFAS 133. The Company has also entered into
interest rate swap agreements to convert a portion of
its fixed-rate debt to floating rates and one floating-
rate debt issuance to a fixed-rate. These interest rate
hedges are accounted for as fair value hedges or as
cash flow hedges, as defined by SFAS 133.
Since the majority of the Company’s financial
derivative instruments are not traded on a market
exchange, the Company estimates their fair values.
Depending on the type of instrument, the values are
determined by the use of present value methods or
standard option value models with assumptions about
commodity prices based on those observed in
underlying markets. Also, since there is not a reliable
forward market for jet fuel, the Company must
estimate the future prices of jet fuel in order to
measure the effectiveness of the hedging instruments
in offsetting changes to those prices, as required by
SFAS 133. Forward jet fuel prices are estimated
through utilization of a statistical-based regression
50