Southwest Airlines 2003 Annual Report Download - page 53

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would require that all D checks be expensed as incurred beginning in 2005. See Recent Accounting
Developments for further information.
REVENUE RECOGNITION Tickets sold are initially deferred as “Air traffic liability”. Passenger revenue
is recognized when transportation is provided. “Air traffic liability” primarily represents tickets sold for
future travel dates and estimated refunds and exchanges of tickets sold for past travel dates. The majority of
the Company’s tickets sold are nonrefundable. 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 refunded (if the ticket is refundable). A small
percentage of tickets (or partial tickets) expire unused. The Company estimates the amount of future refunds
and exchanges, net of 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 accounting 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
revenue recognition method 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,
exchanges, and forfeitures include, but may not be 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.
Subsequent to third quarter 2001 and through second quarter 2002, the Company experienced a higher than
historical mix of discount, nonrefundable ticket sales. The Company also experienced changes in Customer
travel patterns resulting from various factors, including new airport security measures, concerns about further
terrorist attacks, and an uncertain economy. Consequently, the Company recorded $36 million in additional
passenger revenue in second quarter 2002 as Customers required fewer refunds and exchanges, resulting in
more forfeited tickets. During 2003, refund, exchange, and forfeiture activity returned to more historic, pre-
September 11, 2001, patterns.
FREQUENT FLYER PROGRAM The Company accrues the estimated incremental cost of providing free
travel for awards earned under its Rapid Rewards frequent flyer program. The Company also sells frequent
flyer credits and related services to companies participating in its Rapid Rewards frequent flyer program.
Funds received from the sale of flight segment credits and associated with future travel are deferred and
recognized as “Passenger revenue” when the ultimate free travel awards are flown or the credits expire
unused.
ADVERTISING The Company expenses the costs of advertising as incurred. Advertising expense for the years
ended December 31, 2003, 2002, and 2001 was $155 million, $156 million, and $148 million, respectively.
STOCK-BASED EMPLOYEE COMPENSATION The Company has stock-based compensation plans
covering the majority of its Employee groups, including a plan covering the Company's Board of Directors
and plans related to employment contracts with certain Executive Officers of the Company. The Company
accounts for stock-based compensation utilizing the intrinsic value method in accordance with the provisions of
Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees" and
related Interpretations. Accordingly, no compensation expense is recognized for fixed option plans because
the exercise prices of Employee stock options equal or exceed the market prices of the underlying stock on
the dates of grant. Compensation expense for other stock options is not material.
The following table represents the effect on net income and earnings per share if the Company had applied
the fair value based method and recognition provisions of Statement of Financial Accounting Standards
(SFAS) No. 123, “Accounting for Stock-Based Compensation”, to stock-based Employee compensation: