Southwest Airlines 2010 Annual Report Download - page 93

Applicable accounting provisions require an entity to select a policy of how it records the offset rights to
reclaim cash collateral associated with the related derivative fair value of the assets or liabilities of such
derivative instruments. The Company has elected to present its cash collateral utilizing a net presentation, in
which cash collateral amounts held or provided have been netted against the fair value of outstanding derivative
instruments. The Company’s policy differs depending on whether its derivative instruments are in a net asset
position or a net liability position. If its fuel derivative instruments are in a net asset position with a counterparty,
cash collateral amounts held are first netted against current derivative amounts (those that will settle during the
twelve months following the balance sheet date) associated with that counterparty until that balance is zero, and
then any remainder would be applied against the fair value of noncurrent outstanding derivative instruments
(those that will settle beyond one year following the balance sheet date). If its fuel derivative instruments are in a
net liability position with a counterparty, cash collateral amounts provided are first netted against noncurrent
derivative amounts associated with that counterparty until that balance is zero, and then any remainder would be
applied against the fair value of current outstanding derivative instruments. At December 31, 2010, the entire
$125 million in cash collateral deposits posted with counterparties under the Company’s bilateral collateral
provisions has been netted against noncurrent fuel derivative instruments within Other noncurrent liabilities. The
$60 million in cash collateral deposits held from counterparties at December 31, 2010 is netted against
noncurrent fuel derivative instrument assets within Other assets in the Consolidated Balance Sheet. At
December 31, 2009, of the $330 million in cash collateral deposits posted with counterparties under the
Company’s bilateral collateral provisions, $238 million was netted against noncurrent fuel derivative instruments
within Other noncurrent liabilities and $92 million was netted against current fuel derivative instruments within
Accrued liabilities in the Consolidated Balance Sheet.
11. Fair Value Measurements
Accounting standards pertaining to fair value measurements establish a three-tier fair value hierarchy, which
prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such
as quoted prices for identical instruments in active markets; Level 2, defined as inputs other than quoted prices in
active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in
which little or no market data exists, therefore requiring an entity to develop its own assumptions and use
significant judgment.
As of December 31, 2010, the Company held certain items that are required to be measured at fair value on
a recurring basis. These include cash equivalents, short-term investments (primarily treasury bills and certificates
of deposit), certain noncurrent investments, interest rate derivative contracts, fuel derivative contracts, and
available-for-sale securities. The majority of the Company’s short-term investments consist of instruments
classified as Level 1. However, certificates of deposit are classified as Level 2, due to the fact that the fair value
for these instruments is determined utilizing observable inputs in non-active markets. Noncurrent investments
consist of certain auction rate securities, primarily those collateralized by student loan portfolios, which are
guaranteed by the U.S. Government. Other available-for-sale securities primarily consist of investments
associated with the Company’s excess benefit plan. The Company did not have any assets or liabilities measured
at fair value on a nonrecurring basis as of December 31, 2010 or 2009.
The Company’s fuel and interest rate derivative instruments consist of over-the-counter (OTC) contracts,
which are not traded on a public exchange. Fuel derivative instruments include swaps, as well as different types
of option contracts, whereas interest rate derivatives consist solely of swap agreements. See Note 10 for further
information on the Company’s derivative instruments and hedging activities. The fair values of swap contracts
are determined based on inputs that are readily available in public markets or can be derived from information
available in publicly quoted markets. Therefore, the Company has categorized these swap contracts as Level 2.
The Company determines the value of option contracts utilizing a standard option pricing model based on inputs
that are either readily available in public markets, can be derived from information available in publicly quoted
markets, or are quoted by financial institutions that trade these contracts. Because certain of the inputs used to
determine the fair value of option contracts are unobservable (principally implied volatility), the Company has
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