Southwest Airlines 2015 Annual Report Download - page 75

future cash flows (i.e., jet fuel prices) has been consistently applied during 2015, 2014, and 2013, and
has not changed for either assessing or measuring hedge ineffectiveness during these periods.
The Company believes it is unlikely that materially different estimates for the fair value of financial
derivative instruments and forward jet fuel prices would be made or reported based on other reasonable
assumptions or conditions suggested by actual historical experience and other data available at the time
estimates were made.
Fair Value Measurements
The Company utilizes unobservable (Level 3) inputs in determining the fair value of certain assets and
liabilities. At December 31, 2015, these primarily included a portion of its fuel derivative option
contracts, which were a net liability of $1.7 billion.
The Company determines the fair value of fuel derivative 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 quoted by its counterparties. In situations
where the Company obtains inputs via quotes from its counterparties, it verifies the reasonableness of
these quotes via similar quotes from another counterparty as of each date for which financial
statements are prepared. 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. Due to the fact that certain inputs used in determining estimated fair value
of its option contracts are considered unobservable (primarily implied volatility), the Company has
categorized these option contracts as Level 3.
As discussed in Note 10 to the Consolidated Financial Statements, any changes in fair value of cash
flow hedges that are considered to be effective, as defined, are offset within AOCI until the period in
which the expected future cash flow impacts earnings. Any changes in the fair value of fuel derivatives
that are ineffective, as defined, or that do not qualify for hedge accounting, are reflected in earnings
within Other (gains) losses, net, in the period of the change. Because the Company has extensive
historical experience in valuing the derivative instruments it holds, and such experience is continually
evaluated against its counterparties each period when such instruments expire and are settled for cash,
the Company believes it is unlikely that an independent third party would value the Company’s
derivative contracts at a significantly different amount than what is reflected in the Company’s
financial statements. In addition, the Company also has bilateral credit provisions in some of its
counterparty agreements, which provide for parties (or the Company) to provide cash collateral when
the fair value of fuel derivatives with a single party exceeds certain threshold levels. Since this cash
collateral is based on the estimated fair value of the Company’s outstanding fuel derivative contracts,
this provides further validation to the Company’s estimate of fair values.
Frequent Flyer Accounting
The Company utilizes estimates in the recognition of liabilities associated with its frequent flyer
program. These estimates primarily include the liability associated with Rapid Rewards frequent flyer
member (“Member”) account balances that are expected to be redeemed for travel or other products at
a future date. Frequent flyer account balances include points earned through flights taken, points sold
to Customers, or points earned through business partners participating in the frequent flyer program.
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