Southwest Airlines 2014 Annual Report Download - page 103

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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 jet
fuel, 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, put 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 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.
Software capitalization
The Company capitalizes certain internal and external costs related to the acquisition and
development of internal use software during the application development stages of projects. The
Company amortizes these costs using the straight-line method over the estimated useful life of the
software, which typically ranges from five to fifteen years. Costs incurred during the preliminary project
or the post-implementation/operation stages of the project are expensed as incurred. Capitalized computer
software, included as a component of Ground property and equipment in the accompanying Consolidated
Balance Sheet, net of accumulated depreciation, was $403 million and $357 million at December 31,
2014, and 2013, respectively. Computer software depreciation expense was $122 million, $90 million,
95