Southwest Airlines 2006 Annual Report Download - page 55

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2006
1. Summary of Significant Accounting Policies
Basis of Presentation
Southwest Airlines Co. (Southwest) is a major
domestic airline that provides point-to-point, low-fare
service. The Consolidated Financial Statements include
the accounts of Southwest and its wholly owned subsid-
iaries (the Company). All significant intercompany bal-
ances 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 matu-
rities 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.
Short-Term Investments
Short-term investments consist of auction rate secu-
rities with auction reset periods of less than 12 months.
These investments are classified as available-for-sale secu-
rities and are stated at fair value. At each reset period, the
Company accounts for the transaction as “Proceeds from
sales of short-term investments” for the security relin-
quished, and a “purchase of short-term investment” for
the security purchased, in the accompanying Consoli-
dated Statement of Cash Flows. Prior year amounts have
been adjusted to conform to the current year presenta-
tion. Unrealized gains and losses, net of tax, are recog-
nized in “Accumulated other comprehensive income
(loss)” in the accompanying Consolidated Balance
Sheet. Realized gains and losses on specific investments,
which totaled $17 million in 2006, $4 million in 2005,
and $5 million in 2004, are reflected in “Interest income”
in the accompanying Consolidated Income Statement.
Inventories
Inventories primarily consist of flight equipment
expendable parts, materials, aircraft fuel, and supplies.
All of these items 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 23 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 and 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 primarily has 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, mod-
ifications or improvements to the aircraft, 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 and
amortization expense, as required by GAAP.
When appropriate, the Company evaluates its long-
lived assets used in operations for impairment. Impair-
ment losses would be recorded when events and circum-
stances 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
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