relative selling prices.  

 

We defer revenue for the mileage credits related to passenger ticket sales and recognize it as passenger revenue when miles are redeemed and services are provided. We record the air transportation portion of the passenger ticket sales in air traffic liability and recognize these amounts in passenger revenue when we provide transportation or when the ticket expires unused. A hypothetical 10% increase in our estimate of the standalone selling price of a mileage credit would decrease passenger revenue by approximately $50 million, as a result of an increase in the amount of revenue deferred from the mileage component of passenger ticket sales.  

 

Sale of Mileage Credits. Customers may earn mileage credits through participating companies such as credit card companies, hotels and car rental agencies with which we have marketing agreements to sell mileage credits. Our contracts to sell mileage credits under these marketing agreements have two deliverables: (1) the mileage credits redeemable for future travel and (2) the marketing component.  



Our most significant contract to sell mileage credits relates to our co-brand credit card relationship with American Express. We defer revenue related to the mileage credits sold to American Express based on prices at which we sell mileage credits to other airlines, and re-evaluate our deferral rate at least annually. We allocate an amount to the marketing component in an amount equal to the excess of the amount received over the mileage component. Under this approach (the "residual method”), the deferred revenue from the mileage component is recognized as passenger revenue when miles are redeemed and services are provided, while the portion of the revenue related to the marketing component is recognized as those marketing services are provided. We will continue to use the residual method until our contract with American Express is materially modified. If we materially modify this agreement, we will then be required to allocate the consideration received to the marketing and the mileage components based upon their relative selling prices (“relative selling price method”). A material modification of this contract and the resultant change from the residual method to the relative selling price method could impact our deferral rate or cause an adjustment to our deferred revenue balance, which could materially impact our future financial results.  

 

Breakage. For mileage credits which we estimate are not likely to be redeemed (“breakage”), we recognize the associated value proportionally during the period in which the remaining mileage credits are expected to be redeemed. Management uses statistical models to estimate breakage based on historical redemption patterns. A change in assumptions as to the period over which mileage credits are expected to be redeemed, the actual redemption activity for mileage credits or the estimated fair value of mileage credits expected to be redeemed could have a material impact on our revenue in the year in which the change occurs and in future years. At December 31, 2012, the aggregate deferred revenue balance associated with the SkyMiles