Financial Report for Southwest Airlines Term Paper

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Accounting Framework

The reclassification of this expense from an aggregated category to a specific one, Fuel and oil expense, reflects a shift in how hedging will be done in the future within Southwest. Hedging was treated as a pre-emptive financial strategy within the air carrier, often managed completely off the Income Statement and included in accrued or long-term liabilities (Carter, Rogers, Simkins, 54). Given the market-to-market impact of fuel contracts being negative ($73M in 2009 per the annual report) and the ineffectiveness of fuel hedges settling in future periods of -$97M the net effect on the company's profitability will be a -$54M reduction in asset valuation. This is compared to a $92M valuation in 2008. This significant shift in the valuation of hedging contracts led to the redefinition of the expense category as well.

Lessons Learned

Despite the losses incurred by Southwest with their hedging strategies in 2009, the results are not as negative as they appear.

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The company still has hedged oil futures at a rate of 80%, which is one of the riskiest levels in commercial aviation, yet guarantees them exceptionally low-priced fuel if the price rises again. This is the gamble Southwest continually makes and the majority of the time, wins. Given the volatility in oil pricing and reduction in passenger traffic, Southwest still broke at a profit for the year as well. The years of hedging paid off in mitigating what could have been a very challenging year for them otherwise......

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