Southwest Airlines 2012 Annual Report Download - page 92

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under the previous program, but is allowing members to continue to redeem those balances for award travel
under the prior program rules for a period of time. The transition method used by the Company in moving
Members to the new program resulted in no material changes in the Company’s estimation of its existing
frequent flyer liabilities as of the launch date. Although the current program is still relatively new and the
Company does expect a reduction in the amount of spoilage associated with points earned within the program
compared to its previous program, the impact of such expected reduction has thus far not been material.
Advertising
Advertising costs are charged to expense as incurred. Advertising and promotions expense for the years
ended December 31, 2012, 2011, and 2010 was $223 million, $237 million, and $202 million, respectively, and
is included as a component of Other operating expense in the accompanying Consolidated Statement of Income.
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. The Company accounts for share-based compensation based
on its grant date fair value. See Note 14.
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 also has interest
rate swap agreements to convert a portion of its fixed-rate debt to floating rates and, including instruments
acquired from AirTran, has swap agreements that convert certain floating-rate debt 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 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 fuel 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 in connection 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.
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