American Airlines 2005 Annual Report Download - page 57

54
1. Summary of Accounting Policies (Continued)
Frequent Flyer Program The estimated incremental cost of providing free travel awards is accrued when such
award levels are reached. American also accrues a frequent flyer liability for the mileage credits that are expected
to be used for travel on participating airlines based on historical usage patterns and contractual rates. American
sells mileage credits and related services to companies participating in its frequent flyer program. The portion of
the revenue related to the sale of mileage credits, representing the revenue for air transportation sold, is valued at
current market rates and is deferred and amortized over 28 months, which approximates the expected period
over which the mileage credits are used. The remaining portion of the revenue, representing the marketing
products sold and administrative costs associated with operating the AAdvantage program, is recognized upon
sale as a component of passenger revenues, as the related services have been provided. The Company’s total
liability for future AAdvantage award redemptions for free, discounted or upgraded travel on American, American
Eagle or participating airlines as well as unrecognized revenue from selling AAdvantage miles was approximately
$1.5 billion and $1.4 billion (and is recorded as a component of Air traffic liability on the accompanying
consolidated balance sheets) at December 31, 2005 and 2004, respectively.
Tax Contingencies The Company has reserves for taxes and associated interest that may become payable in
future years as a result of audits by tax authorities. Although the Company believes that the positions taken on
previously filed tax returns are reasonable, it nevertheless has established tax and interest reserves in recognition
that various taxing authorities may challenge the positions taken by the Company resulting in additional liabilities
for taxes and interest. The tax reserves are reviewed as circumstances warrant and adjusted as events occur
that affect the Company’s potential liability for additional taxes, such as lapsing of applicable statutes of
limitations, conclusion of tax audits, additional exposure based on current calculations, identification of new
issues, release of administrative guidance, or rendering of a court decision affecting a particular tax issue.
Advertising Costs The Company expenses the costs of advertising as incurred. Advertising expense was
$144 million, $146 million and $150 million for the years ended December 31, 2005, 2004 and 2003, respectively.
Stock Options The Company accounts for its stock-based compensation plans in accordance with Accounting
Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) and related
Interpretations. Under APB 25, no compensation expense is recognized for stock option grants if the exercise
price of the Company’s stock option grants is at or above the fair market value of the underlying stock on the date
of grant. The Company has adopted the pro forma disclosure features of Statement of Financial Accounting
Standards No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), as amended by Statement of
Financial Accounting Standards No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”.
As required by SFAS 123, pro forma information regarding net loss and loss per share have been determined as
if the Company had accounted for its employee stock options and awards granted using the fair value method
prescribed by SFAS 123. The fair value for the stock options was estimated at the date of grant using a Black-
Scholes option pricing model with the following weighted-average assumptions for 2005, 2004 and 2003: risk-free
interest rates ranging from 2.93% to 3.97%; dividend yields of 0%; expected stock volatility of 55%; and expected
life of the options ranging from 3.6 years to 4.0 years.