Southwest Airlines 2002 Annual Report Download - page 56

SOUTHWEST AIRLINES CO. 2002 10-K | 37
Financial Derivative Instruments. The
Company utilizes a variety of derivative
instruments, including both crude oil and
heating oil based derivatives, to hedge a
portion of its exposure to jet fuel price
increases. These instruments consist primarily
of purchased call options, collar structures,
and fixed price swap agreements. Prior to
2001, the net cost paid for option premiums
and gains and losses on all financial
derivative instruments, including those termi-
nated or settled early, were deferred and
charged or credited to “Fuel and oil” expense
in the same month that the underlying jet fuel
being hedged was used. However, beginning
January 1, 2001, the Company adopted
Statement of Financial Accounting Standards
No. 133 (SFAS 133), “Accounting for
Derivative Instruments and Hedging
Activities,” as amended, which changed the
way it accounts for financial derivative
instruments. See Note 2 and Note 9.
Since the majority of the Company’s
financial derivative instruments are not traded
on a market exchange, the Company esti-
mates 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 the observation of similar commodity
futures prices (such as crude oil and heating
oil) and adjusted based on historical
variations to those like commodities.
Recent Accounting Developments. In
November 2002 the Financial Accounting
Standards Board (FASB) issued Interpretation
No. 45, “Guarantor’s Accounting and
Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness
of Others,” which disclosures are effective for
financial statements issued after
December 15, 2002. While the Company has
various guarantees included in contracts in
the normal course of business, primarily in the
form of indemnities, these guarantees would
only result in immaterial increases in future
costs, but do not represent significant
commitments or contingent liabilities of the
indebtedness of others.
In January 2003, FASB issued Interpretation
No. 46, “Consolidation of Variable Interest
Entities” (FIN 46) which requires the consoli-
dation of variable interest entities, as
defined. FIN 46 is applicable to financial
statements to be issued by the Company after
2002; however, disclosures are required
currently if the Company expects to
consolidate any variable interest entities. The
Company does not currently believe that any
material entities will be consolidated with
Southwest as a result of FIN 46.
2. Accounting Changes
Effective January 1, 2001, the Company
adopted SFAS 133. SFAS 133 requires the
Company to record all financial derivative
instruments on its balance sheet at fair value.
Derivatives that are not designated as hedges
must be adjusted to fair value through
income. If a derivative is designated as a
hedge, depending on the nature of the hedge,
changes in its fair value that are considered
to be effective, as defined, either offset the
change in fair value of the hedged assets,
liabilities, or firm commitments through
earnings or are recorded in “Accumulated
other comprehensive income (loss)” until the
hedged item is recorded in earnings. Any
portion of a change in a derivative’s fair value
that is considered to be ineffective, as
defined, is recorded immediately in “Other
(gains) losses, net” in the Consolidated
Statement of Income. Any portion of a change
in a derivative’s fair value that the Company