Southwest Airlines 2003 Annual Report Download - page 55

RECENT ACCOUNTING DEVELOPMENTS In fourth quarter 2003, the Accounting Standards Executive
Committee of the American Institute of Certified Public Accountants released a Draft Statement of Position
entitled "Accounting for Certain Costs and Activities Related to Property, Plant, and Equipment" (Draft
SOP). The Draft SOP, which is expected to be issued in its final form in first quarter 2004, would become
effective for the Company January 1, 2005. The primary areas of applicability of the Draft SOP to the
Company are in the areas of planned major maintenance activities (D checks) and component accounting.
As discussed in “Aircraft and Engine Maintenance”, the Company currently capitalizes costs related to D
checks and amortizes those costs 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. In the Draft SOP, D checks would be considered a
planned major maintenance activity and, as such, would be expensed as incurred. During 2003, the Company
recorded $49 million in “Depreciation expense” related to previously capitalized D checks, compared to the $47
million in D check costs that were capitalized during 2003. These amounts are not necessarily indicative of those
experienced in previous periods or to be expected in future periods, however, as maintenance schedules can vary
significantly from year to year. As of December 31, 2003, the Company has $185 million, net of related
accumulated depreciation, in capitalized D checks classified as “Flight equipment” in the Consolidated Balance
Sheet. Upon the expected adoption of the Draft SOP in 2005, any remaining unamortized costs of planned major
maintenance activities (D checks) would be expensed as a cumulative effect of accounting change adjustment
(charge) in the first quarter of that year.
The Draft SOP also requires, among other things, management to establish a level of “component” accounting,
as defined, for property and equipment. The Draft SOP defines a component as a tangible part of property or
equipment that is accounted for separately and is expected to provide benefit for more than one year. Each
component of property and equipment shall be depreciated over its own separate useful life, and once it is
replaced with a new component, any remaining value would be written off to expense in the period of
replacement. Although the Company is still studying the Draft SOP as it relates to component accounting,
Southwest does not expect its future results of operation or financial position to be materially affected by the
application of component accounting.
In January 2003, FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities” (FIN 46)
which requires the consolidation of variable interest entities, as defined. FIN 46, as revised, is applicable to
financial statements of companies that have interests in “special purpose entities”, as defined, during 2003. FIN
46 is applicable to financial statements of companies that have interests in all other types of entities, in first
quarter 2004. 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 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 beginning 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).
Upon adoption of SFAS 133, the Company recorded the fair value of its fuel derivative instruments in the
Consolidated Balance Sheet and a deferred
g
ain of $46 million
,
net of tax
,
in "Accumulated other com
p
rehensive