Southwest Airlines 2002 Annual Report Download - page 42

SOUTHWEST AIRLINES CO. 2002 10-K | 23
Critical Accounting Policies and Estimates
The Company’s consolidated financial state-
ments have been prepared in accordance with
United States generally accepted accounting
principles (GAAP). The Company’s significant
accounting policies are described in Note 1 to
the Consolidated Financial Statements. The
preparation of financial statements in accord-
ance with GAAP requires the Company’s
management to make estimates and assump-
tions that affect the amounts reported in the
consolidated financial statements and accom-
panying footnotes. The Company’s estimates and
assumptions are based on historical experiences
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
As described in Note 1 to the Consolidated
Financial Statements, tickets sold 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”
primarily represents tickets sold for future travel
dates and estimated future refunds, exchanges,
or forfeitures of tickets sold for past travel dates.
The Company’s air traffic liability balance at
December 31, 2002, was $412.2 million.
The majority of the Company’s tickets sold are
nonrefundable, which is the primary source of
forfeited tickets. Tickets 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). A
small percentage of tickets (or partial tickets)
expire unused. Fully refundable tickets are rarely
forfeited. “Air traffic liability” includes an
estimate of the amount of future refunds,
exchanges, and forfeitures for all unused tickets
once the flight date has passed. These estimates
are based on historical experience over many
years. The Company and members of the airline
industry have consistently applied this account-
ing method to estimate revenue from forfeited
tickets at the date travel is provided. Estimated
future refunds and exchanges included in the air
traffic liability account are constantly evaluated
based on subsequent refund and exchange
activity to validate the accuracy of the Company’s
estimates with respect to forfeited tickets. 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;
however, these differences have historically not
been material. Additional factors that may affect
estimated refunds include, but may not b e
limited to, the Company’s refund and exchange
policy, the mix of refundable and nonrefundable
fares, and fare sale activity. The Company’s
estimation techniques have been consistently
applied from year to year; however, as with any
estimates, actual refund and exchange activity
may vary from estimated amounts.
Since September 2001, the Company has
experienced fluctuations in estimated refunds
and exchanges, and correspondingly, forfeited
tickets, due to many of the factors described
above. Following the terrorist events of
September 11, 2001, and the subsequent
temporary shutdown of U.S. air space, Southwest
temporarily suspended its normal refund policy in
order to provide the highest Service to the
Company’s Customers, including the refunding of
nonrefundable tickets upon Customer request. As
a result, the Company experienced refunds
during September 2001 and through December
2001 far above historical refund levels and in
excess of the Company’s contractual obligations.