Southwest Airlines 2009 Annual Report Download - page 65

Download and view the complete annual report

Please find page 65 of the 2009 Southwest Airlines annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.

Page out of 108

  • 1
  • 2
  • 3
  • 4
  • 5
  • 6
  • 7
  • 8
  • 9
  • 10
  • 11
  • 12
  • 13
  • 14
  • 15
  • 16
  • 17
  • 18
  • 19
  • 20
  • 21
  • 22
  • 23
  • 24
  • 25
  • 26
  • 27
  • 28
  • 29
  • 30
  • 31
  • 32
  • 33
  • 34
  • 35
  • 36
  • 37
  • 38
  • 39
  • 40
  • 41
  • 42
  • 43
  • 44
  • 45
  • 46
  • 47
  • 48
  • 49
  • 50
  • 51
  • 52
  • 53
  • 54
  • 55
  • 56
  • 57
  • 58
  • 59
  • 60
  • 61
  • 62
  • 63
  • 64
  • 65
  • 66
  • 67
  • 68
  • 69
  • 70
  • 71
  • 72
  • 73
  • 74
  • 75
  • 76
  • 77
  • 78
  • 79
  • 80
  • 81
  • 82
  • 83
  • 84
  • 85
  • 86
  • 87
  • 88
  • 89
  • 90
  • 91
  • 92
  • 93
  • 94
  • 95
  • 96
  • 97
  • 98
  • 99
  • 100
  • 101
  • 102
  • 103
  • 104
  • 105
  • 106
  • 107
  • 108

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
December 31, 2009
passenger costs such as fuel, food, and other operational costs, but does not include any contribution to overhead
or profit. The Company does not accrue for partially earned frequent flyer awards. Due to the expected expiration
of a portion of frequent flyer credits making up partial awards, not all of them will turn into useable award
tickets. Likewise, not all award tickets will be redeemed for future travel.
The Company also sells frequent flyer credits and related services to companies participating in its Rapid
Rewards frequent flyer program. Funds received from the sale of flight segment credits are accounted for using
the residual method. Under this method, the Company has determined the portion of funds received for sale of
flight segment credits that relate to free travel, currently estimated at 75 percent of the amount received per flight
segment credit sold. These amounts are deferred and recognized as “Passenger revenue” when the ultimate free
travel awards are flown or the credits expire unused. The remaining 25 percent of the amount received per flight
segment credit sold (the residual), which is assumed not to be associated with future travel, includes items such
as access to the Company’s frequent flyer program population for marketing/solicitation purposes on a monthly
or quarterly basis, use of the Company’s logo on co-branded credit cards, and other trademarks, designs, images,
etc. of the Company for use in marketing materials. This residual portion is recognized in “Other revenue” in the
period earned, which the Company has determined is the period in which it has fulfilled its obligation under the
contract signed with the particular business partner, which is on a monthly or quarterly basis, upon sale, as the
related marketing services are performed or provided.
Advertising
The Company expenses the costs of advertising as incurred. Advertising expense for the years ended
December 31, 2009, 2008, and 2007 was $204 million, $199 million, and $191 million, respectively.
Share-based Employee compensation
The Company has share-based compensation plans covering the majority of its Employee groups, including
a plan covering the Company’s Board of Directors and plans related to employment contracts with the Chairman
Emeritus of the Company. The Company accounts for share-based compensation based on its grant date fair
value. See Note 14.
Financial derivative instruments
The Company accounts for financial derivative instruments at fair value and applies special hedge
accounting rules where appropriate. The Company utilizes various derivative instruments, including crude oil,
unleaded gasoline, and heating oil-based derivatives, to attempt to reduce the risk of its exposure to jet fuel price
increases. These instruments primarily consist of purchased call options, collar structures, and fixed-price swap
agreements, and upon proper qualification are accounted for as cash-flow hedges. The Company has also entered
into interest rate swap agreements to convert a portion of its fixed-rate debt to floating rates and one floating-rate
debt issuance to a fixed-rate. These interest rate hedges are accounted for as fair value hedges or as cash flow
hedges.
Since the majority of the Company’s financial derivative instruments are not traded on a market exchange,
the Company estimates their fair values. Depending on the type of instrument, the values are determined by the
use of present value methods or standard option value models with assumptions about commodity prices based
on those observed in underlying markets. Also, since there is not a reliable forward market for jet fuel, the
Company must estimate the future prices of jet fuel in order to measure the effectiveness of the hedging
instruments in offsetting changes to those prices. Forward jet fuel prices are estimated through utilization of a
statistical-based regression equation with data from market forward prices of like commodities. This equation is
then adjusted for certain items, such as transportation costs, that are stated in the Company’s fuel purchasing
contracts with its vendors.
57