Southwest Airlines 2015 Annual Report Download - page 71

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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 funds that are
past flight date and remain unused. 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 involves some level of subjectivity and judgment. The majority of Southwest’s
tickets sold are nonrefundable, which is the primary source of unused tickets. 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. 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 some tickets can be refunded. This policy also
applies to unused Customer funds that may be the result of an exchange downgrade. A small
percentage of tickets (or partial tickets) expire unused. Fully refundable tickets rarely expire unused.
Estimates of tickets that will expire unused are based on historical experience over many years.
Southwest has 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 spoiled tickets differing significantly from estimates. The Company evaluates its
estimates within a narrow range of acceptable amounts. If actual spoilage 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 spoiled
tickets 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 techniques have been consistently applied from year to year; however, as with
any estimates, actual spoiled tickets may vary from estimated amounts. During 2014, the Company
revised assumptions regarding Customer behavior subsequent to the implementation of its No Show
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