Southwest Airlines 2013 Annual Report Download - page 74

In estimating the lives and expected residual values of its aircraft, the Company primarily has relied upon
actual experience with the same or similar aircraft types, current and projected future market information, and
recommendations from Boeing. Aircraft estimated useful lives are based on the number of “cycles” flown (one
take-off and landing) as well as the aircraft age. The Company has made a conversion of cycles into years based
on both historical and anticipated future utilization of the aircraft. Subsequent revisions to these estimates, which
can be significant, could be caused by changes to aircraft maintenance programs, changes in utilization of the
aircraft (actual cycles during a given period of time), governmental regulations on aging aircraft, and changing
market prices of new and used aircraft of the same or similar types. The Company evaluates its estimates and
assumptions each reporting period and, when warranted, adjusts these estimates and assumptions. Generally,
these adjustments are accounted for on a prospective basis through depreciation and amortization expense. For
example, during third quarter 2012, the Company changed the estimated residual values of its entire remaining
fleet of owned 737-300 and 737-500 aircraft. Based on current and expected future market conditions related to
these aircraft, as well as a significant change in the way the Company expected to utilize the fleet, the Company
reduced the residual values of these aircraft. This determination was made based on the continuous assessment of
the market 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 increased the supply of older aircraft
on the market. As this reduction in residual value is considered a change in estimate, it was accounted for on a
prospective basis, and thus the Company has effectively accelerated the recording of depreciation expense over
the remainder of the useful lives for each aircraft. The Company does not believe these changes in estimates
towards the end of the useful lives for a given fleet type are unusual, especially given the rapid pace of
technological advancement, volatile fuel prices, and recent significant transactions involving the Company’s
fleet. The 2012 reduction in estimated salvage value resulted in a $34 million increase in depreciation expense
during the second half of the year, and increased 2013 expense by approximately $26 million. See Note 3 to the
Consolidated Financial Statements for further information.
The Company evaluates its long-lived assets for impairment. Factors that would indicate potential
impairment may include, but are not limited to, significant decreases in the market value of the long-lived
asset(s), a significant change in the long-lived asset’s physical condition, and operating or cash flow losses
associated with the use of the long-lived asset. The Company has continued to operate virtually all of its aircraft,
generate positive cash flow, and produce operating profits. Consequently, the Company has not identified any
impairment related to its existing aircraft fleet. The Company will continue to monitor its long-lived assets and
the airline operating environment.
The Company believes it is unlikely that materially different estimates for expected lives, expected residual
values, and impairment evaluations would be made or reported based on other reasonable assumptions or
conditions suggested by actual historical experience and other data available at the time estimates were made.
Financial derivative instruments
The Company utilizes financial derivative instruments primarily to manage its risk associated with
changing jet fuel prices. See “Quantitative and Qualitative Disclosures about Market Risk” for more information
on these risk management activities, and see Note 10 to the Consolidated Financial Statements for more
information on the Company’s fuel hedging program and financial derivative instruments.
All derivatives are required to be reflected at fair value and recorded on the Consolidated Balance Sheet.
At December 31, 2013, the Company was a party to over 706 separate financial derivative instruments related to
its fuel hedging program for the years 2014 through 2017. Changes in the fair values of these instruments can
vary dramatically based on changes in the underlying commodity prices, as has been evident in recent years. For
example, during 2012, market “spot” prices for West Texas Intermediate crude oil peaked at a high of
approximately $110 per barrel and hit a low price of approximately $78 per barrel. During 2013, market spot
prices ranged from a high of $111 per barrel to a low of $87 per barrel. Market price changes can be driven by
factors such as supply and demand, inventory levels, weather events, refinery capacity, political agendas, the
value of the U.S. dollar, geopolitical events, and general economic conditions, among other items. The financial
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