Southwest Airlines 2002 Annual Report Download - page 57

38 | SOUTHWEST AIRLINES CO. 2002 10-K
elects to exclude from its measurement of
effectiveness is required to be recorded
immediately in earnings.
Under the rules established by SFAS 133,
the Company has alternatives in accounting
for its financial derivative instruments. The
Company primarily uses financial derivative
instruments to hedge its exposure to jet fuel
price increases and accounts for these
derivatives as cash flow hedges, as defined.
In accordance with SFAS 133, the Company
must comply with detailed rules and strict
documentation requirements prior to begin-
ning hedge accounting. As required by SFAS
133, the Company assesses the effectiveness
of each of its individual hedges on a quarterly
basis. The Company also examines the
effectiveness of its entire hedging program on
a quarterly basis utilizing statistical analysis.
This analysis involves utilizing regression and
other statistical analyses that compare
changes in the price of jet fuel to changes in
the prices of the commodities used for
hedging purposes (crude oil and heating oil).
If these statistical techniques do not produce
results within certain predetermined
confidence levels, the Company could lose its
ability to utilize hedge accounting, which could
cause the Company to recognize all gains and
losses on financial derivative instruments in
earnings in the periods following the
determination that the Company no longer
qualified for hedge accounting. This could, in
turn, depending on the materiality of periodic
changes in derivative fair values, increase the
volatility of the Company’s future earnings.
Upon adoption of SFAS 133, the Company
recorded the fair value of its fuel derivative
instruments in the Consolidated Balance
Sheet and a deferred gain of $46.1 million,
net of tax, in “Accumulated other comprehen-
sive income (loss).” See Note 10 for further
information on Accumulated other compre-
hensive income (loss). During 2002 and 2001,
the Company recognized $4.5 million in
additional income and $8.2 million in
expense, respectively, in “Other (gains)
losses, net,” related to the ineffectiveness
of its hedges. During 2002 and 2001,
the Company recognized approximately
$25.6 million and $17.5 million, respectively,
of net expense, related to amounts excluded
from the Company’s measurements of hedge
effectiveness, in “Other (gains) losses, net.”
The 2001 adoption of SFAS 133 has resulted
in more volatility in the Company’s financial
statements than in the past due to the
changes in market values of its derivative
instruments and some ineffectiveness that
has been experienced in its fuel hedges. See
Note 9 for further information on the
Company’s derivative instruments.
Effective January 1, 2000, the Company
adopted Staff Accounting Bulletin 101 (SAB
101) issued by the Securities and Exchange
Commission in December 1999. As a result of
adopting SAB 101, the Company changed the
way it recognizes revenue from the sale of
flight segment credits to companies partici-
pating in its Rapid Rewards frequent flyer
program. Prior to the issuance of SAB 101, the
Company recorded revenue in “Other
revenue” when flight segment credits were
sold. Beginning January 1, 2000, the Company
recognizes Passenger revenue when free
travel awards resulting from the flight segment
credits sold are flown or credits expire
unused. Due to this change, the Company
recorded a cumulative effect charge in first
quarter 2000 of $22.1 million (net of income
taxes of $14.0 million) or $.03 per share,
basic and diluted.
3. Federal Grants and Special Charges Related to
Terrorist Attack s
On September 11, 2001, terrorists hijacked
and used two American Airlines, Inc. aircraft
and two United Air Lines, Inc. aircraft in
terrorist attacks on the United States (terrorist
attacks). As a result of these terrorist attacks,
the Federal Aviation Administration (FAA)
immediately suspended all commercial airline
flights. The Company resumed flight activity o n