Financial Statement Investigation A02-18-2015

Financial Statement Investigation A02-18-2015
FSI Revised 02-11-2020
ASSIGNMENT #3
Revenue Recognition; Allowance for Doubtful Accounts; Prepaid and Accrued Expenses
A. Revenue Recognition - The following revenue recognition footnote is from Southwest Air-
lines 2019 10-K (its annual report filed with the Securities and Exchange Commission):
Tickets sold are initially deferred as Air traffic liability. Passenger revenue is recognized and Air traffic
liability is reduced when transportation is provided. Air traffic liability primarily represents tickets sold for
future travel dates, funds that are past flight date and remain unused, but are expected to be used in
the future, and the Company’s liability for loyalty benefits that are expected to be redeemed in the fu-
ture. The majority of the Company’s tickets sold are nonrefundable. Southwest has a No Show policy
that applies to fares that are not canceled or changed by a Customer at least ten minutes prior to a
flight's scheduled departure. Nonrefundable tickets that are sold but not flown on the travel date, and
are canceled in accordance with the No Show policy, can be applied to future travel. A small percent-
age of tickets (or partial tickets) expire unused. The Company estimates the amount of tickets that ex-
pire unused and recognizes such amounts in Passenger revenue once the scheduled flight date has
lapsed in proportion to the pattern of flights taken by the Customer. Based on the Company's revenue
recognition policy, revenue is recorded at the flight date for a Customer who does not change his/her
itinerary and loses his/her funds as the Company has then fulfilled its performance obligation. Initial
spoilage estimates for both tickets and funds available for future use are routinely adjusted and ulti-
mately finalized once the tickets expire, which is typically twelve months after the original purchase
date. Spoilage estimates are based on the Company's Customers' historical travel behavior.
Southwest’s balance at December 31, 2019 is on page 2 of this document.

1. Assume that you purchased a nonrefundable ticket from Southwest on December 15,
2019 for $1,000 in cash for travel on January 15, 2020. Using T-accounts, how would
Southwest account (what accounts would be affected) for your ticket purchase in its fi-
nancial statements for the year ended December 31, 2019?
2. Assume that it is now January, 2020, and you used your January 15, 2020 Southwest
ticket as you originally planned. How would Southwest account (what accounts would be
affected) for your usage of your ticket in its financial statements for the year ended De-
cember 31, 2020? Use T-accounts to answer the question. Would cash flow be affected?
Norman J. Bartczak, Columbia University, prepared this assignment as a basis for class discussion. It is not intended to illustrate
either effective of ineffective handling of an administrative situation. Copyright © 2015 Norman J. Bartczak.
1
AIPA – Assignment #3 A02-18-2015
Revised 02-11-2020
Southwest Airlines Co.

Consolidated Balance Sheet
(in millions, except share data)
December 31, 2019 December 31, 2018

ASSETS
Current assets:
Cash and cash equivalents $ 2,548 $ 1,854
Short-term investments 1,524 1,835
Accounts and other receivables 1,086 568
Inventories of parts and supplies, at cost 529 461
Prepaid expenses and other current assets 287 310
Total current assets 5,974 5,028
Property and equipment, at cost:
Flight equipment 21,629 21,753
Ground property and equipment 5,672 4,960
Deposits on flight equipment purchase contracts 248 775
Assets constructed for others 164 1,768
27,713 29,256
Less allowance for depreciation and amortization 10,688 9,731
17,025 19,525
Goodwill 970 970
Operating lease right-of-use assets 1,349 —
Other assets 577 720
$ 25,895 $ 26,243
LIABILITIES AND STOCKHOLDERS' EQUITY

Current liabilities:
Accounts payable $ 1,574 $ 1,416
Accrued liabilities 1,749 1,749
Current operating lease liabilities 353 —
Air traffic liability 4,457 4,134
Current maturities of long-term debt 819 606
Total current liabilities 8,952 7,905
Long-term debt less current maturities 1,846 2,771
Air traffic liability - noncurrent 1,053 936
Deferred income taxes 2,364 2,427
Construction obligation 164 1,701
Noncurrent operating lease liabilities 978 —
Other noncurrent liabilities 706 650
Stockholders' equity:
Common stock, $1.00 par value: 2,000,000,000 shares authorized;
807,611,634 shares issued in 2019 and 2018 808 808
Capital in excess of par value 1,581 1,510
Retained earnings 17,945 15,967
Accumulated other comprehensive income (loss) (61 ) 20
Treasury stock, at cost: 288,547,318 and 255,008,275 shares
in 2019 and 2018 respectively (10,441 ) (8,452)
Total stockholders' equity 9,832 9,853
$ 25,895 $ 26,243
2
A02-18-2015 AIPA – Assignment #3
Revised 02-11-2020
B. Allowance for Doubtful Accounts

Overlook Inn has the following accounts in its balance sheet at the end of its fiscal year on Au-
gust 31, 2019:
Accounts Receivable Allowance for Doubtful Accounts
----------------------------------------------- -----------------------------------------------
+ | - - | +
$2,000 | | $500
| |
| |
| |
| |
1. Assume it is now the end of Overlook’s fiscal year on August 31, 2020.
a. In September 2019, Overlook received $1,500 from one of the accounts receivable cus-
tomers. Record (“bookkeep”) Overlook’s receipt of the $1,500.
b. After numerous attempts throughout fiscal 2020 (ending on August 31, 2020) to locate
the customer who owes them the $500, Overlook decided to “write-off” the $500 account
receivable and give up any future efforts to collect it. How would Overlook record
(“bookkeep”) the write-off of the $500 in its fiscal 2020 financial statements?
3
AIPA – Assignment #3 A02-18-2015
Revised 02-11-2020
C. Prepaid Expenses
On August 15, 2019, Overlook Inn does not yet know what its income tax expense will be for
its fiscal year ending August 31, 2019. Since an estimated income tax payment for fiscal year
2019 is due on August 15, 2019, Overlook sends a payment of $10,000 to the U.S. Internal
Revenue Service.
1. Using T-accounts, record (“bookkeep”) Overlook’s August 15, 2019 $10,000 payment on
August 15, 2019.
2. It is now the end of Overlook’s 2019 fiscal year (August 31, 2019), and Overlook is finaliz-
ing the preparation of its fiscal 2019 financial statements. It has determined that its income
tax expense for the year to be $4,200. Using T-accounts, record (“bookkeep”) Overlook’s
income tax expense of $4,200.
3. Using T-accounts, show how Overlook’s balance sheet accounts relating to income taxes
should look on August 31, 2019. You will need to reconcile Overlook’s accounting for its
$10,000 tax payment on August 15, 2019 with its accounting for its income tax expense of
$4,200 on August 31, 2019.
4
A02-18-2015 AIPA – Assignment #3
Revised 02-11-2020
D. Accrued Expenses
Assume that, in order to conserve Overlook’s cash outflow, the Darby’s decided to wait until
September 2019 to pay themselves the $100,000 in salaries ($50,000 each) they earned and
were owed for working at Overlook throughout fiscal 2019 (ended on August 31, 2019).
1. Using T-accounts, record the Darbys’ salaries, if applicable, on Overlook’s fiscal 2019 fi-
nancial statements.
2. In October 2019, the Darbys pay themselves the $100,000 in salaries they earned in fiscal
2019. Record Overlook’s payment of $100,000 to the Darbys in October 2019.

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Financial Statement Investigation A02-18-2015

FSI Revised 02-11-2020

Southwest’s balance at December 31, 2019 is on page 2 of this document.

Southwest Airlines Co.

December 31, 2019 December 31, 2018

LIABILITIES AND STOCKHOLDERS' EQUITY

B. Allowance for Doubtful Accounts

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