Southwest Airlines 2007 Annual Report Download - page 47

Revenue Recognition
As described in Note 1 to the Consolidated Finan-
cial Statements, tickets sold for passenger air travel are
initially deferred as “Air traffic liability.” Passenger rev-
enue is recognized and air traffic liability is reduced when
the service is provided (i.e., when the flight takes place).
“Air traffic liability” represents tickets sold for future
travel dates and estimated future refunds and exchanges of
tickets sold for past travel dates. The balance in “Air
traffic liability” fluctuates throughout the year based on
seasonal travel patterns and fare sale activity. The Com-
pany’s “Air traffic liability” balance at December 31,
2007 was $931 million, compared to $799 million as of
December 31, 2006.
Estimating the amount of tickets that will be
refunded, exchanged, or forfeited involves some level of
subjectivity and judgment. The majority of the Company’s
tickets sold are nonrefundable, which is the primary source
of forfeited tickets. According to the Company’s “Con-
tract of Carriage”, tickets (whether refundable or nonre-
fundable) 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 can be refunded (if the ticket is refundable). A
small percentage of tickets (or partial tickets) expire
unused. Fully refundable tickets are rarely forfeited. “Air
traffic liability” includes an estimate of 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 esti-
mate revenue from forfeited tickets at the date of travel.
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 estimates with respect to for-
feited tickets. Holding other factors constant, a ten-per-
cent change in the Company’s estimate of the amount of
refunded, exchanged, or forfeited tickets for 2007 would
have resulted in a $20 million, or .2%, change in Passenger
revenues recognized for that period.
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. The Company
evaluates its estimates within a narrow range of acceptable
amounts. If actual refunds, exchanges, or forfeiture expe-
rience results in an amount outside of this range, esti-
mates and assumptions are reviewed and adjustments to
“Air traffic liability” and to “Passenger revenue” are
recorded, as necessary. Additional factors that may affect
estimated refunds and exchanges include, but may not be
limited to, the Company’s refund and exchange policy,
the mix of refundable and nonrefundable fares, and pro-
motional fare activity. The Company’s estimation tech-
niques have been consistently applied from year to year;
however, as with any estimates, actual refund, exchange,
and forfeiture activity may vary from estimated amounts.
No material adjustments were recorded for years 2005,
2006, or 2007.
The Company believes it is unlikely that materially
different estimates for future refunds, exchanges, and
forfeited tickets would be reported based on other rea-
sonable assumptions or conditions suggested by actual
historical experience and other data available at the time
estimates were made.
Accounting for Long-Lived Assets
As of December 31, 2007, the Company had
approximately $15.2 billion (at cost) of long-lived assets,
including $13.0 billion (at cost) in flight equipment and
related assets. Flight equipment primarily relates to the
434 Boeing 737 aircraft in the Company’s fleet at
December 31, 2007, which are either owned or on capital
lease. The remaining 86 Boeing 737 aircraft in the
Company’s fleet at December 31, 2007, are on operating
lease. In accounting for long-lived assets, the Company
must make estimates about the expected useful lives of the
assets, the expected residual values of the assets, and the
potential for impairment based on the fair value of the
assets and the cash flows they generate.
The following table shows a breakdown of the
Company’s long-lived asset groups along with informa-
tion about estimated useful lives and residual values of
these groups:
Estimated Useful Life
Estimated
Residual
value
Aircraft and engines . . . 23 to 25 years 15%
Aircraft parts . . . . . . . . Fleet life 4%
Ground property and
equipment . . . . . . . . 5 to 30 years 0%-10%
Leasehold
improvements . . . . . . 5 years or lease term 0%
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. Aircraft estimated
useful lives are based on the number of “cycles” flown
(one take-off and landing). The Company has made a
conversion of cycles into years based on both its historical
and anticipated future utilization of the aircraft.
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