Southwest Airlines 2012 Annual Report Download - page 72

conditions, sometimes materially. Critical accounting policies and estimates are defined as those that both (i) are
most important to the portrayal of the Company’s financial condition and results and (ii) require management’s
most subjective judgments. The Company’s most critical accounting policies and estimates are described below.
Revenue recognition
Tickets sold for Passenger air travel are initially deferred as Air traffic liability. Passenger revenue is
recognized and Air traffic liability is reduced when the service is provided (i.e., when the flight takes place). Air
traffic liability primarily represents tickets sold for future travel dates and estimated future refunds and
exchanges of tickets sold for past travel dates. The balance in Air traffic liability, which includes a portion of the
Company’s liability associated with its frequent flyer program, fluctuates throughout the year based on seasonal
travel patterns, fare sale activity, and activity associated with the Company’s frequent flyer programs.
For air travel on Southwest, the amount of tickets that will expire unused are estimated and recognized in
Passenger revenue once the scheduled flight date has passed. Estimating the amount of tickets that will expire
unused, be refunded, or exchanged involves some level of subjectivity and judgment. The majority of
Southwest’s tickets sold are nonrefundable, which is the primary source of unused tickets. According to
Southwest’s “Contract of Carriage,” tickets (whether refundable or nonrefundable) that are sold but not flown on
the travel date can be reused for another flight, up to a year from the date of sale, or can be refunded (if the ticket
is refundable). This policy also applies to unused Customer funds that may be left over from exchanging a less
expensive ticket for a previously purchased ticket that was more expensive. A small percentage of tickets (or
partial tickets) expire unused. Fully refundable tickets are rarely forfeited. Estimates of tickets that will expire
unused are based on historical experience over many years. Southwest and other airlines have consistently
applied this accounting method to estimate revenue from unused tickets at the date of scheduled travel. Holding
other factors constant, a 10 percent change in the Company’s estimate of the amount of tickets that will expire
unused would have resulted in a $33 million, or 0.22 percent, change in Passenger revenues recognized for 2012.
Events and circumstances outside of historical fare sale activity or historical Customer travel patterns can
result in actual refunds, exchanges, or forfeited tickets differing significantly from estimates. The Company
evaluates its estimates within a narrow range of acceptable amounts. If actual refunds, exchanges, or forfeiture
experience results in an amount outside of this range, estimates and assumptions are reviewed and adjustments to
Air traffic liability and to Passenger revenue are recorded, as necessary. Additional factors that may affect
estimated refunds and exchanges include, but may not be limited to, changes to the Company’s ticketing policies,
the Company’s refund, exchange, and unused funds policies, the mix of refundable and nonrefundable fares,
promotional fare activity, and the impact of the economic environment on Customer behavior. The Company’s
estimation techniques have been consistently applied from year to year; however, as with any estimates, actual
refund, exchange, and forfeiture activity may vary from estimated amounts.
The Company believes it is unlikely that materially different estimates for future refunds, exchanges, and
forfeited tickets would be reported based on other reasonable assumptions or conditions suggested by actual
historical experience and other data available at the time estimates were made.
Accounting for long-lived assets
Flight equipment and related assets make up the majority of the Company’s long-lived assets. Flight
equipment primarily relates to the 497 Boeing 737 aircraft and 10 Boeing 717 aircraft in the Company’s fleet at
December 31, 2012, which are either owned or on capital lease. The remaining 109 Boeing 737 aircraft and
78 Boeing 717 aircraft in the Company’s fleet at December 31, 2012, are operated under operating leases. In
accounting for long-lived assets, the Company must make estimates about the expected useful lives of the assets,
the expected residual values of the assets, and the potential for impairment based on the fair value of the assets
and their future expected cash flows.
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