Southwest Airlines 2005 Annual Report Download - page 54

SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)
markets. Also, since there is not a reliable forward SFAS 123R for all share-based payments granted after
market for jet fuel, the Company must estimate the that date, and based on the requirements of SFAS 123
future prices of jet fuel in order to measure the effective- for all unvested awards granted prior to the effective
ness of the hedging instruments in offsetting changes to date of SFAS 123R. Under the ""modified retrospective''
those prices, as required by SFAS 133. Forward jet fuel method, the requirements are the same as under the
prices are estimated through the observation of similar ""modified prospective'' method, but also permit entities
commodity futures prices (such as crude oil, heating oil, to restate financial statements of previous periods based
and unleaded gasoline) and adjusted based on historical on proforma disclosures made in accordance with
variations to those like commodities. See Note 10 for SFAS 123.
further information on SFAS 133 and financial deriva- The Company currently utilizes a standard option
tive instruments. pricing model (i.e., Black-Scholes) to measure the fair
value of stock options granted to Employees. While
Income Taxes. The Company accounts for de-
SFAS 123R permits entities to continue to use such a
ferred income taxes utilizing Statement of Financial
model, the standard also permits the use of a more
Accounting Standards No. 109 (SFAS 109), ""Ac-
complex binomial, or ""lattice'' model. Based upon re-
counting for Income Taxes'', as amended. SFAS 109
search done by the Company on the alternative models
requires an asset and liability method, whereby deferred
available to value option grants, and in conjunction with
tax assets and liabilities are recognized based on the tax
the type and number of stock options expected to be
effects of temporary differences between the financial
issued in the future, the Company has determined that
statements and the tax bases of assets and liabilities, as
it will continue to use the Black-Scholes model for
measured by current enacted tax rates. When appropri-
option valuation as of the current time.
ate, in accordance with SFAS 109, the Company evalu-
ates the need for a valuation allowance to reduce SFAS 123R includes several modifications to the
deferred tax assets. way that income taxes are recorded in the financial
statements. The expense for certain types of option
2. Accounting Changes grants is only deductible for tax purposes at the time
that the taxable event takes place, which could cause
Share-based Compensation variability in the Company's effective tax rates recorded
In December 2004, the FASB issued throughout the year. SFAS 123R does not allow compa-
SFAS No. 123R, ""Share-Based Payment''. nies to ""predict'' when these taxable events will take
SFAS No. 123R is a revision of SFAS No. 123, place. Furthermore, it requires that the benefits associ-
""Accounting for Stock Based Compensation'', and su- ated with the tax deductions in excess of recognized
persedes APB 25. Among other items, SFAS 123R compensation cost be reported as a financing cash flow,
eliminates the use of APB 25 and the intrinsic value rather than as an operating cash flow as required under
method of accounting, and requires companies to recog- current literature. This requirement will reduce net
nize the cost of employee services received in exchange operating cash flows and increase net financing cash
for awards of equity instruments, based on the grant flows in periods after the effective date. These future
date fair value of those awards, in the financial state- amounts cannot be estimated, because they depend on,
ments. Pro forma disclosure is no longer an alternative among other things, when employees exercise stock
under the new standard. Although early adoption is options. However, the amount of operating cash flows
allowed, the Company will adopt SFAS 123R as of the recognized in prior periods for such excess tax deduc-
required effective date for calendar year companies, tions, as shown in the Company's Consolidated State-
which is January 1, 2006. ment of Cash Flows, were $65 million, $35 million, and
$41 million, respectively, for 2005, 2004, and 2003.
SFAS 123R permits companies to adopt its re-
quirements using either a ""modified prospective'' The Company is still evaluating which method of
method, or a ""modified retrospective'' method. Under adoption it will use. Subject to a complete review of the
the ""modified prospective'' method, compensation cost requirements of SFAS 123R, based on stock options
is recognized in the financial statements beginning with granted to Employees through December 31, 2005, the
the effective date, based on the requirements of Company expects that the adoption of SFAS 123R on
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