Southwest Airlines 2010 Annual Report Download - page 77

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Share-based Employee compensation
The Company has share-based compensation plans covering several of its Employee groups, including plans
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 15.
Financial derivative instruments
The Company accounts for financial derivative instruments at fair value and applies 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 consist primarily of purchased call options, collar structures, call spreads, 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 appropriately designated as either 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.
For the effective portion of settled hedges, the Company records the associated gains or losses as a
component of Fuel and oil expense in the Consolidated Statement of Income. For amounts representing
ineffectiveness, as defined, or changes in fair value of derivative instruments for which hedge accounting is not
applied, the Company records any gains or losses as a component of Other (gains) losses, net, in the Consolidated
Statement of Income. Amounts that are paid or received associated with the purchase or sale of financial
derivative instruments (i.e., premium costs of option contracts) are classified as a component of Other (gains)
losses, net, in the Consolidated Statement of Income in the period in which the instrument settles or expires. All
cash flows associated with purchasing and selling derivatives are classified as operating cash flows in the
Consolidated Statement of Cash Flows, within Changes in certain assets and liabilities. See Note 10 for further
information on hedge accounting and financial derivative instruments.
The Company classifies its cash collateral provided to or held from counterparties in a “net” presentation on
the Consolidated Balance Sheet against the fair value of the derivative positions with those counterparties. See
Note 10 for further information.
Software capitalization
The Company capitalizes certain internal and external costs related to the acquisition and development of
internal use software during the application development stages of projects. The Company amortizes these costs
using the straight-line method over the estimated useful life of the software, which ranges from five to ten years.
Costs incurred during the preliminary project or the post-implementation/operation stages of the project are
expensed as incurred.
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