Southwest Airlines 2015 Annual Report Download - page 76

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Under the Southwest Rapid Rewards frequent flyer program, Members earn points for every dollar
spent. The amount of points earned under the program is based on the fare and fare class purchased,
with higher fare products (e.g., Business Select) earning more points than lower fare products (e.g.,
Wanna Get Away). Each fare class is associated with a points earning multiplier, and points for flights
are calculated by multiplying the fare for the flight by the fare class multiplier. Likewise, the amount of
points required to be redeemed for a flight is based on the fare and fare class purchased. Under the
program, (i) Members are able to redeem their points for every available seat, every day, on every
flight, with no blackout dates; and (ii) points do not expire so long as the Rapid Rewards Member has
points-earning activity during a 24-month time period. In addition, Southwest co-branded Chase Visa
credit card holders are able to redeem their points for items other than travel on Southwest Airlines,
such as international flights on other airlines, cruises, hotel stays, rental cars, gift cards, event tickets,
and more. In addition to earning points for revenue flights and qualifying purchases with Rapid
Rewards Partners, Rapid Rewards Members also have the ability to purchase, gift, and transfer points,
as well as the ability to donate points to selected charities.
The Company utilizes the incremental cost method of accounting for points earned through flights taken
in its frequent flyer program. A liability is recorded for the estimated incremental cost of providing free
travel as points are being earned. The liability recorded represents the total number of points expected to
be redeemed by Members, regardless of whether the Members may have enough to qualify for a full
travel award. The incremental cost liability is primarily composed of direct Passenger costs such as fuel,
food, and other operational costs, but does not include any contribution to fixed overhead costs or profit.
At December 31, 2015, the incremental cost liability was approximately $58 million.
The Company also sells frequent flyer points and related services to business partners participating in
the frequent flyer program. The majority of the points sold to business partners are through the
Southwest co-branded Chase Visa credit card. Historically, funds received from the sale of points
associated with these agreements were accounted for under the residual method. Under the residual
method, the Company estimated the percent of the amount received from frequent flyer points sold
associated with Southwest’s co-branded Chase Visa credit card that related to free travel. The
estimated amounts associated with free travel are deferred and recognized as Passenger revenue when
the ultimate free travel awards are flown. During third quarter 2015, the Company executed an
amended co-branded credit card agreement (“Agreement”) with Chase Bank USA, N.A. (“Chase”),
which materially modified the previously existing agreement between Chase and the Company.
Consideration received as part of this Agreement is subject to ASU 2009-13, “Multiple-Deliverable
Revenue Arrangements—a consensus of the FASB Emerging Issues Task Force.” The modified
Agreement has the following multiple elements: travel points to be awarded; use of the Southwest
Airlines’ brand and access to Rapid Reward Member lists; advertising elements; and the Company’s
resource team. Under ASU 2009-13, these deliverables are accounted for separately and allocation of
consideration from the Agreement is determined based on the relative selling price of each deliverable.
The application of ASU 2009-13 to the Agreement decreases the relative value of the air transportation
deliverables that the Company records as deferred revenue (and ultimately Passenger revenues when
redeemed awards are flown) and increases the relative value of the marketing-related deliverables
recorded in Other revenues at the time these marketing-related deliverables are provided. This is
principally due to the previous application of the residual method, which effectively applied the entire
discount associated with the agreement to the marketing deliverables.
Significant management judgment was used to estimate the selling price of each of the deliverables.
The objective was to determine the price at which the Company would transact a sale if the product or
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