Southwest Airlines 2010 Annual Report Download - page 80

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The Company is expected to incur substantial integration and transition expenses in connection with the
Merger, including the necessary costs associated with integrating the operations of the two companies. While the
Company has assumed that a certain level of expenses would be incurred, there are many factors that could affect
the total amount or the timing of the expenses, and many of the expenses that will be incurred are, by their
nature, difficult to estimate. These expenses could, particularly in the near term, exceed the savings that the
Company expects to achieve from the Merger and likely will result in the Company taking significant charges
against earnings following the completion of the Merger. The amount and timing of such charges are currently
uncertain.
3. Accounting Changes And New Accounting Pronouncements
During third quarter 2010, the Company changed the estimated residual values of its entire remaining fleet
of owned 737-300 and 737-500 aircraft. Based on recent sales of 737-300 aircraft previously in the Company’s
fleet and expectations of future market conditions related to these aircraft, the Company reduced the residual
values of these aircraft from approximately 15 percent of original cost to approximately 10 percent of original
cost. This determination was made due to the lack of buyers for these older aircraft, as many buyers of used
aircraft prefer newer, more fuel efficient models, and the increase in the number of airlines retiring these older
aircraft, which has effectively “flooded” the market. As this reduction in residual value is considered a change in
estimate, it has been accounted for on a prospective basis, and thus the Company will record additional
depreciation expense over the remainder of the useful lives for each aircraft. The impact of this change for 2010
was an increase in depreciation expense of approximately $9 million, excluding the impact of profitsharing and
income taxes ($4 million after the impact of profitsharing and taxes, resulting in no impact on reported net
income per share, basic and diluted).
Effective January 1, 2010, the Company made a change in its accounting for frequent flyer benefits to begin
accruing for partially earned frequent flyer awards as part of the Company’s incremental cost method of
accounting for frequent flyer benefits. Under the terms of the Company’s current frequent flyer program, the
term partial awards refers to credits earned by Customers for flights taken that in the aggregate total less than 16,
the number required to earn an award for free travel. Previously, the Company only accrued for fully earned
frequent flyer awards. Although the prior policy is an acceptable method under GAAP, the Company believes
accruing for partially earned awards is preferable to its former method because it is a better representation of the
Company’s liability since a portion of the partially earned awards will eventually turn into fully earned awards.
Additionally, accruing for partially earned awards is more consistent with the Company’s accounting for fully
earned awards, and it is consistent with the accounting policy used by other airlines that utilize the incremental
cost approach to account for frequent flyer awards.
In accordance with accounting requirements associated with voluntary changes in accounting, the Company
made a retrospective adjustment to its Consolidated Balance Sheet as of December 31, 2009, the earliest period
presented, to apply the new method of accounting for frequent flyer benefits. In the Consolidated Statement of
Stockholders’ Equity, this retrospective adjustment was made to Retained earnings as of December 31, 2007, the
earliest period presented, as well as the balances as of December 31, 2008 and 2009. The Company’s Consolidated
Statement of Income and Consolidated Statement of Cash Flows for 2009 and 2008 were not retrospectively
adjusted as the impact of this change in accounting for frequent flyer benefits was immaterial. In addition, this
elective change in accounting did not have a material impact on the Company’s earnings or cash flows for the year
ended December 31, 2010. The adjustment from the change in accounting principle was as follows:
(i) Accrued liabilities increased $19 million;
(ii) Deferred income tax liability decreased $7 million; and
(iii) Retained earnings decreased $12 million.
On September 23, 2009, the Financial Accounting Standards Board (“FASB”) ratified Accounting Standards
Update (“ASU”) No. 2009-13 (formerly referred to as Emerging Issues Task Force Issue No. 08-1), “Revenue
74