Southwest Airlines 2010 Annual Report Download - page 59

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changes in the business environment. However, actual results may differ from estimates under different
conditions, sometimes materially. Critical accounting policies and estimates are defined as those that are both
most important to the portrayal of the Company’s financial condition and results and require management’s most
subjective judgments. The Company’s most critical accounting policies and estimates are described below.
Revenue recognition
Tickets sold for Passenger air travel are initially deferred as Air traffic liability. Passenger revenue 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 Company’s Air traffic liability balance at December 31, 2010,
was $1.2 billion, compared to $1.0 billion as of December 31, 2009.
The Company estimates the amount of tickets that will expire unused and recognizes such amounts in
Passenger revenue once the scheduled flight date has passed. Estimating the amount of tickets that will expire
unused, be refunded, or exchanged involves some level of subjectivity and judgment. The majority of the
Company’s tickets sold are nonrefundable, which is the primary source of unused tickets. According to the
Company’s “Contract of Carriage,” tickets (whether refundable or nonrefundable) 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. Estimates of tickets that will expire unused are based on historical experience over many years. The
Company and other airlines have consistently applied this accounting method to estimate revenue from unused
tickets at the date of travel. Holding other factors constant, a 10 percent change in the Company’s estimate of the
amount of tickets that will expire unused would have resulted in a $26 million, or .2 percent, change in Passenger
revenues recognized for 2010.
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
experience results in an amount outside of this range, estimates 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, changes to the Company’s ticketing policies,
the Company’s refund and exchange policy, the mix of refundable and nonrefundable fares, promotional fare
activity, and the impact of the economic environment on Customer behavior. The Company’s estimation
techniques have been consistently applied from year to year; however, as with any estimates, actual refund,
exchange, and forfeiture activity may vary from estimated amounts. During 2009, as a result of the Company’s
efforts to stimulate demand through fare sales, Passenger revenues consisted of a higher percentage of discount
tickets flown and a lower percentage of fully refundable tickets flown. Consequently, the Company’s estimate of
the amount of refunded, exchanged, or forfeited tickets recorded during 2009 was in a range of approximately 30
to 35 percent higher than what it believes its historical averages would indicate. The Company believes these
estimates are supported by actual data and are reasonable given the underlying fact patterns. During 2008 and
2010, the Company believes the amount of refunded, exchanged, or forfeited tickets recorded were closer to what
historical trends would indicate.
The Company believes it is unlikely that materially different estimates for future refunds, exchanges, and
forfeited tickets would be reported based on other reasonable 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, 2010, the Company had approximately $16.3 billion (at cost) of long-lived assets,
including $14.0 billion (at cost) in flight equipment and related assets. Flight equipment primarily relates to the
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