Southwest Airlines 2011 Annual Report Download - page 108

Applicable accounting provisions require an entity to select a policy for 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. In the accompanying Consolidated Balance Sheet, 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 application of this 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 is applied against the
fair value of noncurrent outstanding derivative instruments (those that will settle beyond one year following the
balance sheet date). If the Company’s fuel derivative instruments are in a net liability position with the
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 is applied against the fair value of
current outstanding derivative instruments. At December 31, 2011, of the entire $226 million in cash collateral
deposits posted with counterparties under the Company’s bilateral collateral provisions, $41 million has been
netted against noncurrent fuel derivative instruments within Other noncurrent liabilities and $185 million has
been netted against current fuel derivative instruments within Accrued liabilities in the Consolidated Balance
Sheet. 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.
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 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.
As of December 31, 2011, the Company held certain items that are required to be measured at fair value on
a recurring basis. These included cash equivalents, short-term investments (primarily treasury bills, commercial
paper, 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, the Company has certificates of deposit and commercial
paper that 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’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 an 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 provided 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 categorized
these option contracts as Level 3. The fair value of option contracts considers both the intrinsic value and any
102