Southwest Airlines 2010 Annual Report Download - page 64

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Frequent flyer accounting
The Company utilizes estimates in its recognition of liabilities associated with its frequent flyer program.
These estimates include the liability associated with frequent flyer awards that have been issued, are outstanding,
and are expected to be redeemed at a future date, amounts associated with partially earned awards that are
expected to turn into fully earned awards and be redeemed at a future date, and amounts associated with frequent
flyer credits sold to companies participating in its Rapid Rewards frequent flyer program.
The Company utilizes the incremental cost method of accounting for frequent flyer awards issued and for
partially earned awards (i.e., flight credits) earned in the Company’s Rapid Rewards frequent flyer program. The
term partial award refers to flight credits earned by Customers for flights taken that in the aggregate are less than
the amount needed to earn a frequent flyer award. The Company records a liability and reduction of Passenger
revenue for the estimated incremental cost of providing free travel as frequent flyer awards and partially earned
awards are being earned. The liability recorded by the Company represents the total number of awards and
partially earned awards expected to be redeemed by Customers. The estimated incremental cost of these
liabilities include direct Passenger costs such as fuel, food, and other operational costs, but does not include any
contribution to overhead or profit. Prior to 2010, the Company did not record a liability for partially earned
Customer awards. However, effective January 1, 2010, the Company made a voluntary change in its accounting
for frequent flyer benefits to begin accruing for partially earned frequent flyer awards. See Note 3 to the
Consolidated Financial Statements for further information about this accounting change. At December 31, 2010,
the Company had approximately 13.9 million full or partial awards outstanding, of which approximately
10.9 million were partially earned awards.
The Company also sells frequent flyer credits and related services to companies participating in its frequent
flyer program. Funds received from the sale of flight segment credits are accounted for under the residual
method. Under this method, as of December 31, 2010, the Company has estimated that approximately 83 percent
of the amount received per flight segment credit sold relates to free travel, and the remaining 17 percent
associated with items such as access to the Company’s frequent flyer program population for marketing/
solicitation purposes, 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 apportionment of value between free travel and
marketing services is estimated based on several factors, including fares, the habits of Customers in redeeming
awards for free travel, and the contractual rate paid by companies for the flight segment credits. Prior to 2010, the
amount estimated to be associated with free travel had historically ranged from 75 percent to 82 percent. The
estimated amounts associated with free travel are deferred and recognized as Passenger revenue when the
ultimate free travel awards are flown or the credits expire unused. For the portion of funds received that is
deemed not to be associated with future travel, the Company has determined that the period earned is the period
in which the Company 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.
The vast majority of these marketing services consist of the access granted, either monthly or quarterly, to
various lists of the Company’s frequent flyer members. The estimated amount that is not associated with free
travel is recognized in Other revenue in the period earned.
The Company believes it is unlikely that materially different estimates for the assumptions used in
estimating the liabilities associated with its frequent flyer program would be made based on the conditions
suggested by actual historical experience and other data available at the time estimates were made.
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