Southwest Airlines 2014 Annual Report Download - page 78

CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The Company’s Consolidated Financial Statements have been prepared in accordance with
GAAP. The Company’s significant accounting policies are described in Note 1 to the Consolidated
Financial Statements. The preparation of financial statements in accordance with GAAP requires the
Company’s management to make estimates and assumptions that affect the amounts reported in the
Consolidated Financial Statements and accompanying footnotes. The Company’s estimates and
assumptions are based on historical experience and changes in the business environment. However,
actual results may differ from estimates under different conditions, sometimes materially. Critical
accounting policies and estimates are defined as those that both (i) are most important to the portrayal
of the Company’s financial condition and results and (ii) require management’s most subjective
judgments. The Company’s most critical accounting policies and estimates are described below.
Revenue recognition
Tickets sold for Passenger air travel are initially deferred as Air traffic liability. Passenger
revenue is recognized and Air traffic liability is reduced when the service is provided (i.e., when the
flight takes place). Air traffic liability primarily represents tickets sold for future travel dates and
estimated future refunds and exchanges of tickets sold for past travel dates. The balance in Air traffic
liability, which includes a portion of the Company’s liability associated with its frequent flyer program,
fluctuates throughout the year based on seasonal travel patterns, fare sale activity, and activity
associated with the Company’s frequent flyer program.
For air travel on Southwest, the amount of tickets that will expire unused are estimated and
recognized in Passenger revenue once the scheduled flight date has passed. Estimating the amount of
tickets that will expire unused, be refunded, or exchanged involves some level of subjectivity and
judgment. The majority of Southwest’s tickets sold are nonrefundable, which is the primary source of
unused tickets. According to Southwest’s current “Contract of Carriage,” all refundable tickets that are
sold but not flown on the travel date can be reused for another flight, up to a year from the date of sale,
or can be refunded. This policy also applies to unused Customer funds that may be left over from
exchanging a less expensive ticket for a previously purchased ticket that was more expensive. In
September 2013, Southwest implemented a No Show policy that applies to nonrefundable fares that are
not canceled or changed by a Customer at least ten minutes prior to a flight’s scheduled departure. See
Note 1 to the Consolidated Financial Statements for further information. A small percentage of tickets
(or partial tickets) expire unused. Fully refundable tickets are rarely forfeited. Estimates of tickets that
will expire unused are based on historical experience over many years. Southwest and other airlines
have consistently applied this accounting method to estimate revenue from unused tickets at the date of
scheduled travel.
Events and circumstances outside of historical fare sale activity or historical Customer travel
patterns can result in actual refunds, exchanges, or forfeited tickets differing significantly from
estimates. The Company evaluates its estimates within a narrow range of acceptable amounts. If actual
refunds, exchanges, or forfeiture experience results in an amount outside of this range, estimates and
assumptions are reviewed and adjustments to Air traffic liability and to Passenger revenue are
recorded, as necessary. Additional factors that may affect estimated refunds and exchanges include, but
may not be limited to, changes to the Company’s ticketing policies, the Company’s refund, exchange,
and unused funds policies, the mix of refundable and nonrefundable fares, promotional fare activity,
and the impact of the economic environment on Customer behavior. The Company’s estimation
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