Southwest Airlines 2011 Annual Report Download - page 68

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company’s Consolidated Financial Statements have been prepared in accordance with GAAP. The
Company’s significant accounting policies are described in Note 1 to the Consolidated Financial Statements. The
preparation of financial statements in accordance with GAAP requires the Company’s management to make
estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and
accompanying footnotes. The Company’s estimates and assumptions are based on historical experience and
changes in the business environment. However, actual results may differ from estimates under different
conditions, sometimes materially. Critical accounting policies and estimates are defined as those that are both
most important to the portrayal of the Company’s financial condition and results and require management’s most
subjective judgments. The Company’s most critical accounting policies and estimates are described below.
Revenue recognition
Tickets sold for Passenger air travel are initially deferred as Air traffic liability. Passenger revenue is
recognized and Air traffic liability is reduced when the service is provided (i.e., when the flight takes place). Air
traffic liability represents tickets sold for future travel dates and estimated future refunds and exchanges of
tickets sold for past travel dates. The balance in Air traffic liability fluctuates throughout the year based on
seasonal travel patterns and fare sale activity.
For air travel on Southwest, the amount of tickets that will expire unused are estimated and recognized in
Passenger revenue once the scheduled flight date has passed. Estimating the amount of tickets that will expire
unused, be refunded, or exchanged involves some level of subjectivity and judgment. The majority of
Southwest’s tickets sold are nonrefundable, which is the primary source of unused tickets. According to
Southwest’s “Contract of Carriage,” tickets (whether refundable or nonrefundable) that are sold but not flown on
the travel date can be reused for another flight, up to a year from the date of sale, or can be refunded (if the ticket
is refundable). This policy also applies to unused Customer funds that may be left over from exchanging a less
expensive ticket for a previously purchased ticket that was more expensive. A small percentage of tickets (or
partial tickets) expire unused. Fully refundable tickets are rarely forfeited. Estimates of tickets that will expire
unused are based on historical experience over many years. Southwest and other airlines have consistently
applied this accounting method to estimate revenue from unused tickets at the date of scheduled travel. Holding
other factors constant, a 10 percent change in the Company’s (including AirTran’s) estimate of the amount of
tickets that will expire unused would have resulted in a $37 million, or 0.25 percent, change in Passenger
revenues recognized for 2011.
Events and circumstances outside of historical fare sale activity or historical Customer travel patterns can
result in actual refunds, exchanges, or forfeited tickets differing significantly from estimates. The Company
evaluates its estimates within a narrow range of acceptable amounts. If actual refunds, exchanges, or forfeiture
experience results in an amount outside of this range, estimates and assumptions are reviewed and adjustments to
Air traffic liability and to Passenger revenue are recorded, as necessary. Additional factors that may affect
estimated refunds and exchanges include, but may not be limited to, changes to the Company’s ticketing policies,
the Company’s refund, exchange, and unused funds policies, the mix of refundable and nonrefundable fares,
promotional fare activity, and the impact of the economic environment on Customer behavior. The Company’s
estimation techniques have been consistently applied from year to year; however, as with any estimates, actual
refund, exchange, and forfeiture activity may vary from estimated amounts. During 2009, as a result of the
Company’s efforts to stimulate demand through fare sales, Passenger revenues consisted of a higher percentage
of discount tickets flown and a lower percentage of fully refundable tickets flown. In addition, during 2011, the
Company revised its unused funds policy to restrict the ability of a Customer to transfer funds to another
Customer, which has resulted in an increase in expiration of unused funds. Consequently, the Company’s
estimate of the amount of refunded, exchanged, or forfeited tickets recorded during 2009 and during 2011 was
approximately 30 to 35 percent higher than what it believes its historical averages would indicate for those years.
The Company believes these estimates are supported by actual data and are reasonable given the underlying fact
patterns.
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