Southwest Airlines 2008 Annual Report Download - page 81

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
At December 31, 2008, the Company had posted
$240 million in cash collateral deposits with a
counterparty under these bilateral collateral
provisions. The deposits are included in “Prepaid
expenses and other current assets” on the
Consolidated Balance Sheet.
11. Fair Value Measurements
In September 2006, the Financial Accounting
Standards Board (FASB) issued Statement of
Financial Accounting Standards No. 157, “Fair Value
Measurements” (SFAS 157). SFAS 157 does not
establish requirements for any new fair value
measurements, but it does apply to existing
accounting pronouncements in which fair value
measurements are already required. SFAS 157
defines fair value, establishes a framework for
measuring fair value in accordance with accounting
principles generally accepted in the United States,
and expands disclosures about fair value
measurements. The Company has adopted the
provisions of SFAS 157 as of January 1, 2008, for
financial instruments. Although the adoption of
SFAS 157 has not materially impacted its financial
condition, results of operations, or cash flow, the
Company is now required to provide additional
disclosures as part of its financial statements.
SFAS 157 establishes a three-tier fair value
hierarchy, which prioritizes the inputs used in
measuring fair value. These tiers include: Level 1,
defined as observable inputs such as quoted prices in
active markets; Level 2, defined as inputs other than
quoted prices in active markets that are either directly
or indirectly observable; and Level 3, defined as
unobservable inputs in which little or no market data
exists, therefore requiring an entity to develop its
own assumptions.
As of December 31, 2008, the Company held
certain items that are required to be measured at fair
value on a recurring basis. These included cash
equivalents, short-term investments, certain
noncurrent investments, interest rate derivative
contracts, fuel derivative contracts, and
available-for-sale securities. Cash equivalents consist
of short-term, highly liquid, income-producing
investments, all of which have maturities of 90 days
or less, including money market funds, U.S.
Government obligations, and obligations of U.S.
Government backed agencies. Short-term
investments consist of short-term, highly liquid,
income-producing investments, which have
maturities of greater than 90 days but less than one
year, including U.S. Government obligations,
obligations of U.S. Government backed agencies, and
certain non-taxable auction rate securities. Derivative
instruments are related to the Company’s attempts to
hedge fuel costs and interest rates. Noncurrent
investments consist of auction rate securities
collateralized by student loan portfolios, which are
guaranteed by the U.S. Government. Other
available-for-sale securities primarily consist of
investments associated with the Company’s Excess
Benefit Plan.
The Company’s fuel derivative instruments
consist of over-the-counter (OTC) contracts, which
are not traded on a public exchange. These contracts
include both swaps as well as different types of
option contracts. See Note 10 for further information
on the Company’s derivative instruments and
hedging activities. The fair values of swap contracts
are determined based on inputs that are readily
available in public markets or can be derived from
information available in publicly quoted markets.
Therefore, the Company has categorized these swap
contracts as Level 2. The Company determines the
value of option contracts utilizing a standard option
pricing model based on inputs that are either readily
available in public markets, can be derived from
information available in publicly quoted markets, or
are quoted by financial institutions that trade these
contracts. In situations where the Company obtains
inputs via quotes from financial institutions, it
verifies the reasonableness of these quotes via similar
quotes from another financial institution as of each
date for which financial statements are prepared. The
Company also considers counterparty credit risk and
its own credit risk in its determination of all
estimated fair values. The Company has consistently
applied these valuation techniques in all periods
presented and believes it has obtained the most
accurate information available for the types of
derivative contracts it holds. Due to the fact that
certain of the inputs utilized to determine the fair
value of option contracts are unobservable
(principally implied volatility), the Company has
categorized these option contracts as Level 3.
62