Southwest Airlines 2003 Annual Report Download - page 52

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2003
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION Southwest Airlines Co. (Southwest) is a major domestic airline that provides
predominantly shorthaul, high-frequency, point-to-point, low-fare service. The Consolidated Financial
Statements include the accounts of Southwest and its wholly owned subsidiaries (the Company). All significant
intercompany balances and transactions have been eliminated. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States (GAAP) requires management to
make estimates and assumptions that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from these estimates.
CASH AND CASH EQUIVALENTS Cash in excess of that necessary for operating requirements is invested in
short-term, highly liquid, income-producing investments. Investments with maturities of three months or less are
classified as cash and cash equivalents, which primarily consist of certificates of deposit, money market funds,
and investment grade commercial paper issued by major corporations and financial institutions. Cash and cash
equivalents are stated at cost, which approximates market value.
INVENTORIES Inventories of flight equipment expendable parts, materials, and supplies are carried at average
cost. These items are generally charged to expense when issued for use.
PROPERTY AND EQUIPMENT Depreciation is provided by the straight-line method to estimated residual
values over periods generally ranging from 20 to 25 years for flight equipment and 5 to 30 years for ground
property and equipment once the asset is placed in service. Residual values estimated for aircraft are 15 percent,
except for 737-200 aircraft, which will be retired from the Company’s fleet by the end of first quarter 2005. The
estimated residual value for these aircraft is two percent, based on current market values. Residual value
percentages for ground property and equipment range from zero to 10 percent. Property under capital leases and
related obligations are recorded at an amount equal to the present value of future minimum lease payments
computed on the basis of the Company’s incremental borrowing rate or, when known, the interest rate implicit in
the lease. Amortization of property under capital leases is on a straight-line basis over the lease term and is
included in depreciation expense.
In estimating the lives and expected residual values of its aircraft, the Company has primarily relied upon
actual experience with the same or similar aircraft types and recommendations from Boeing, the
manufacturer of the Company’s aircraft. Subsequent revisions to these estimates, which can be significant,
could be caused by changes to the Company’s maintenance program, changes in utilization of the aircraft
(actual flight hours or cycles during a given period of time), governmental regulations on aging aircraft,
changing market prices of new and used aircraft of the same or similar types, etc. The Company evaluates its
estimates and assumptions each reporting period and, when warranted, adjusts these estimates and
assumptions. Generally, these adjustments are accounted for on a prospective basis through depreciation
expense, as required by GAAP.
When appropriate, the Company evaluates its long-lived assets used in operations for impairment.
Impairment losses would be recorded when events and circumstances indicate that an asset might be
impaired and the undiscounted cash flows to be generated by that asset are less than the carrying amounts of
the asset. Factors that would indicate potential impairment include, but are not limited to, significant
decreases in the market value of the long-lived asset(s), a significant change in the long-lived asset’s physical
condition, operating or cash flow losses associated with the use of the long-lived asset, etc. While the airline
industry as a whole has experienced many of these indicators, Southwest has continued to operate all of its
aircraft and continues to experience positive cash flow.
AIRCRAFT AND ENGINE MAINTENANCE The cost of scheduled engine inspections and repairs and
routine maintenance costs for aircraft and engines are charged to maintenance expense as incurred. Scheduled
airframe inspections and repairs, known as D checks, are generally performed every ten years. Costs related to
D checks are capitalized and amortized over the estimated period benefited, presently the least of ten years, the
time until the next D check, or the remaining life of the aircraft. Modifications that significantly enhance the
operating performance or extend the useful lives of aircraft or engines are capitalized and amortized over the
remaining life of the asset.
In 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public
Accountants issued a Draft Statement of Position entitled "Accounting for Certain Costs and Activities
Related to Property, Plant, and Equipment
"
(Draft SOP). Among other items, the Draft SOP, as written,