Southwest Airlines 2014 Annual Report Download - page 131

Download and view the complete annual report

Please find page 131 of the 2014 Southwest Airlines annual report below. You can navigate through the pages in the report by either clicking on the pages listed below, or by using the keyword search tool below to find specific information within the annual report.

Page out of 156

  • 1
  • 2
  • 3
  • 4
  • 5
  • 6
  • 7
  • 8
  • 9
  • 10
  • 11
  • 12
  • 13
  • 14
  • 15
  • 16
  • 17
  • 18
  • 19
  • 20
  • 21
  • 22
  • 23
  • 24
  • 25
  • 26
  • 27
  • 28
  • 29
  • 30
  • 31
  • 32
  • 33
  • 34
  • 35
  • 36
  • 37
  • 38
  • 39
  • 40
  • 41
  • 42
  • 43
  • 44
  • 45
  • 46
  • 47
  • 48
  • 49
  • 50
  • 51
  • 52
  • 53
  • 54
  • 55
  • 56
  • 57
  • 58
  • 59
  • 60
  • 61
  • 62
  • 63
  • 64
  • 65
  • 66
  • 67
  • 68
  • 69
  • 70
  • 71
  • 72
  • 73
  • 74
  • 75
  • 76
  • 77
  • 78
  • 79
  • 80
  • 81
  • 82
  • 83
  • 84
  • 85
  • 86
  • 87
  • 88
  • 89
  • 90
  • 91
  • 92
  • 93
  • 94
  • 95
  • 96
  • 97
  • 98
  • 99
  • 100
  • 101
  • 102
  • 103
  • 104
  • 105
  • 106
  • 107
  • 108
  • 109
  • 110
  • 111
  • 112
  • 113
  • 114
  • 115
  • 116
  • 117
  • 118
  • 119
  • 120
  • 121
  • 122
  • 123
  • 124
  • 125
  • 126
  • 127
  • 128
  • 129
  • 130
  • 131
  • 132
  • 133
  • 134
  • 135
  • 136
  • 137
  • 138
  • 139
  • 140
  • 141
  • 142
  • 143
  • 144
  • 145
  • 146
  • 147
  • 148
  • 149
  • 150
  • 151
  • 152
  • 153
  • 154
  • 155
  • 156

11. FAIR VALUE MEASUREMENTS
Accounting standards pertaining to fair value measurements establish a three-tier fair value
hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1,
defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other
than quoted prices in active markets that are either directly or indirectly observable; and Level 3,
defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to
develop its own assumptions.
As of December 31, 2014, the Company held certain items that are required to be measured at
fair value on a recurring basis. These included cash equivalents, short-term investments (primarily
treasury bills, commercial paper, and certificates of deposit), certain noncurrent investments, interest
rate derivative contracts, fuel derivative contracts, and available-for-sale securities. The majority of the
Company’s short-term investments consist of instruments classified as Level 1. However, the
Company has certificates of deposit, commercial paper, and Eurodollar time deposits that are classified
as Level 2, due to the fact that the fair value for these instruments is determined utilizing observable
inputs in non-active markets. Noncurrent investments consist of certain auction rate securities,
primarily those collateralized by student loan portfolios, which are guaranteed by the U.S.
Government. Other available-for-sale securities primarily consist of investments associated with the
Company’s excess benefit plan.
The Company’s fuel and interest rate derivative instruments consist of over-the-counter
contracts, which are not traded on a public exchange. Fuel derivative instruments include swaps, as
well as different types of option contracts, whereas interest rate derivatives consist solely of swap
agreements. See Note 10 for further information on the Company’s derivative instruments and hedging
activities. The fair values of swap contracts are determined based on inputs that are readily available in
public markets or can be derived from information available in publicly quoted markets. Therefore, the
Company has categorized these swap contracts as Level 2. The Company’s Treasury Department,
which reports to the Chief Financial Officer, determines the value of option contracts utilizing an
option pricing model based on inputs that are either readily available in public markets, can be derived
from information available in publicly quoted markets, or are provided by financial institutions that
trade these contracts. The option pricing model used by the Company is an industry standard model for
valuing options and is the same model used by the broker/dealer community (i.e., the Company’s
counterparties). The inputs to this option pricing model are the option strike price, underlying price,
risk free rate of interest, time to expiration, and volatility. Because certain inputs used to determine the
fair value of option contracts are unobservable (principally implied volatility), the Company has
categorized these option contracts as Level 3. Volatility information is obtained from external sources,
but is analyzed by the Company for reasonableness and compared to similar information received from
other external sources. The fair value of option contracts considers both the intrinsic value and any
remaining time value associated with those derivatives that have not yet settled. The Company also
considers counterparty credit risk and its own credit risk in its determination of all estimated fair
values. To validate the reasonableness of the Company’s option pricing model, on a monthly basis, the
Company compares its option valuations to third party valuations. If any significant differences were to
be noted, they would be researched in order to determine the reason. However, historically, no
significant differences have been noted. The Company has consistently applied these valuation
techniques in all periods presented and believes it has obtained the most accurate information available
for the types of derivative contracts it holds.
123