Southwest Airlines 2014 Annual Report Download - page 102

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from the Customer and relieves the liability when payments are remitted to the applicable
governmental agency.
Frequent flyer program
The Company records a liability for the estimated incremental cost of providing free travel under
its frequent flyer program for all amounts earned from flight activity that are expected to be redeemed for
future travel. The estimated incremental cost includes direct passenger costs such as fuel, food, and other
operational costs, but does not include any contribution to fixed overhead costs or profit.
Southwest also sells frequent flyer points and related services to companies participating in its
frequent flyer program. Funds received from the sale of these points are accounted for using the residual
method. Under this method, the Company determined the portion of funds received that relate to free
travel were currently estimated to be 100 percent of the amount received under the Company’s Rapid
Reward program as of December 31, 2014. These amounts are deferred and recognized as Passenger
revenue when the ultimate free travel awards are flown. For all points sold to business partners that are
expected to expire unused, the Company recognizes spoilage in accordance with the redemption method.
The Company’s consolidated liability associated with the sale of frequent flyer points and/or flight
credits, was approximately $1.3 billion and $1.1 billion as of December 31, 2014, and 2013, respectively.
This liability is included as part of Air Traffic liability in the Company’s Consolidated Balance Sheet.
During fourth quarter 2014, the Company increased the amount of spoilage recorded associated
with frequent flyer points sold to business partners as a result of continued monitoring of Member
redemption activity and behavior under its Rapid Rewards program. Based on a sufficient amount of
historical data and Member attributes observed since the new program was launched in 2011, the Company
developed a predictive statistical model to analyze the amount of spoilage expected. In estimating spoilage,
the Company takes into account the Member’s past behavior, as well as several factors that are expected to
be indicative of the likelihood of future point redemption. These factors include, but are not limited to,
tenure with program, points accrued in the program, and whether or not the customer has a co-branded
credit card. This change in estimate, which was recorded on a prospective basis, effective October 1, 2014,
increased Passenger revenues by approximately $55 million for the quarter and the year ended
December 31, 2014. After consideration of profitsharing and taxes, the impact of this change to net income
was an increase of $29 million, or $.04 per Basic and Diluted share, for the year ended December 31, 2014.
The higher spoilage rate is expected to continue in 2015; however, the precise revenue impact will not be
determinable until the actual number of point redemptions for the period is known.
Advertising
Advertising costs are charged to expense as incurred. Advertising and promotions expense for
the years ended December 31, 2014, 2013, and 2012 was $207 million, $208 million, and $223 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 certain Employees, 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 9 for further information.
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