This book was set in 10/12 Stix by Aptara, Inc. Printed and bound by Quadgraphics-Versailles.
This book is printed on acid free paper. ∞
Founded in 1807, John Wiley & Sons, Inc. has been a valued source of knowledge and understanding for more than 200 years, helping people around the world meet their needs and fulfill their aspirations. Our company is built on a foundation of principles that include responsibility to the communities we serve and where we live and work. In 2008, we launched a Corporate Citizenship Initiative, a global effort to address the environmental, social, economic, and ethical challenges we face in our business. Among the issues we are addressing are carbon impact, paper specifications and procurement, ethical conduct within our business and among our vendors, and community and charitable support. For more information, please visit our website: www.wiley.com/go/citizenship.
All rights reserved. No part of this work covered by the copyrights herein may be reproduced, transmitted, or used in any form or by any means—graphic, electronic, or mechanical—without the prior written permission of the publisher.
Any request for photocopying, recording, taping, or inclusion in information storage and retrieval systems of any part of this book shall be directed to The Canadian Copyright Licensing Agency (Access Copyright). For an Access Copyright Licence, visit www.accesscopyright.ca or call toll-free, 1-800-893-5777.
Care has been taken to trace ownership of copyright material contained in this text. The publishers will gladly receive any information that will enable them to rectify any erroneous reference or credit line in subsequent editions.
Evaluation copies are provided to qualified academics and professionals for review purposes only, for use in their courses during the next academic year. These copies are licensed and may not be sold or transferred to a third party. Upon completion of the review period, please return the evaluation copy to Wiley. Return instructions and a free of charge return shipping label are available at www.wiley.com/go/ returnlabel. If you have chosen to adopt this textbook for use in your course, please accept this book as your complimentary desk copy. Outside of the United States, please contact your local representative.
ISBN 978-1-119-40700-3 (E-Pub)
The inside back cover will contain printing identification and country of origin if omitted from this page. In addition, if the ISBN on the back cover differs from the ISBN on this page, the one on the back cover is correct.
Printed in the United States of America
10 9 8 7 6 5 4 3 2 1
Dedicated with love and gratitude to my father, Donald Burnley, for being such a wonderful role model in all that is important in life and for guiding me down the accounting path.
About the Author
CHRISTOPHER BURNLEY, FCPA, FCA, is a professor in the Accounting Department at Vancouver Island University’s Faculty of Management. Prior to his full-time academic career, Chris worked for 12 years in public practice and also audited federal government departments and United Nations agencies with the Office of the Auditor General of Canada. Chris also teaches in the CPA Professional Education Program for the CPA Western School of Business.
At Vancouver Island University (VIU), Chris has developed a number of new courses, has served as departmental chair, and
served two terms as an elected faculty representative on the university’s board of governors. He is active internationally, teaching and delivering guest lectures at VIU’s partner institutions in Europe, Asia, and the South Pacific. He has been awarded numerous internal and external grants in support of his academic work and has presented at national conferences. Chris has also taught in the Master of Professional Accounting Program at the Edwards School of Business at the University of Saskatchewan, where he was recognized by the university with the Chartered Professional Accountants of Alberta teaching excellence award.
Chris has received a number of awards from the Canadian Academic Accounting Association for his academic work, including awards for case authoring and developing innovative ideas in accounting education.
Chris is active in the accounting profession, serving as a director on the board of the Chartered Professional Accountants of British Columbia, and is a past chair of the board of the Chartered Professional Accountants’ Education Foundation of BC. In 2007, Chris was awarded the Ritchie W. McCloy Award for CA Volunteerism. Chris is also a co-author of the textbook Financial Accounting: Tools for Business Decision-Making, published by John Wiley & Sons Canada, Ltd.
The aim of Understanding Financial Accounting is to introduce students to the core concepts of financial accounting by illustrating the relevance of the material to a wide variety of decision-making contexts. The focus is on providing students with the tools to help them understand the rationale behind the numbers. If students can develop an understanding of the language of accounting, grasp what the accounting information means, and appreciate what managers are saying when they present the financial information, they will have laid a foundation they can build upon in whatever position they hold in the future.
The material is written at a level meant to be understandable for all students who put the time into working through it. It is based on 18 years of teaching the material to thousands of students with a wide variety of backgrounds, the majority of whom have been non-accounting majors, but also to others who have gone on to medal on national professional accounting exams.
Continuing Features Cohesively Structured Content
The text has been structured around a series of core questions that students may ask themselves about the chapter topics and that they need to be able to answer in order to achieve the learning objectives. The material that follows each question then becomes more relevant to the students and provides them with a clear picture of why they need to understand it. The text also walks students through the basic mechanical elements of financial accounting, because it is very difficult for students to understand accounting information if they lack an understanding of the system used to generate it.
The Take 5 Videos
Each chapter includes a number of whiteboard screen capture videos that students can preview before coming to class or use for review after. These videos are a great tool for instructors who like to flip their classroom. In addition, new Take 5 Videos developed for this edition focus on solution walkthroughs of the end-of-chapter review problems that are in the text.
Opportunities for Classroom Discussion
Each chapter of the text includes features that can form the basis for classroom discussions. These include the Ethics in Accounting feature that highlights ethical issues that must be dealt with in relation to all kinds of accounting situations, the For Example feature that showcases and interprets financial statements of real companies, and the Conceptual Framework feature that discusses the theory behind accounting practices.
Unparalleled Review and Practice Opportunities
Concise and to-the-point chapter summaries recap the key points covered by each learning objective. Chapter End Review Problems, with accompanying Take 5 videos, walk the student through the steps required to solve complex problems.
Each chapter includes a variety of assignment material, enabling faculty to choose the level of breadth and depth at which they want to assess the students. This includes Discussion Questions, Application Problems (now expanded and divided into two sets), User Perspective Problems, Reading and Interpreting Financial Statements problems, and small Cases.
Key Enhancements
This second edition of Understanding Financial Accounting builds on the strength of the innovative first edition. All content has been carefully reviewed and revised to maximize student understanding. Significant work has gone into enhancing the reading content, the assessment material, and the material available in the WileyPLUS course.
Tightened Linkages between the Reading Content and the WileyPLUS Course
WileyPLUS is an innovative, research-based online environment for effective teaching and learning. Among its many features, WileyPLUS allows students to study and practise using the digital textbook, quizzes, and algorithmic exercises. The immediate feedback helps students understand where they need to focus their study efforts.
Based on cognitive science, WileyPLUS with ORION is a personalized adaptive learning experience that gives students the practice they need to build proficiency on topics while using their study time more effectively. The adaptive engine is powered by hundreds of unique questions per chapter, giving students endless opportunities for practice throughout the course. Orion is available with all chapters of this text.
This edition makes a clear link between the reading content and the wealth of pedagogical material available in the WileyPLUS course. The new Assess Your Understanding box at the end of many chapter sections directs students to the relevant Demonstration Problems in the WileyPLUS course. Additional Demonstration Problems are in WileyPLUS and there is now a companion Demonstration Problem for every Chapter End Review Problem, doubling the opportunities for students to practise working through problems.
Augmented End-of-Chapter Material
Revisions based on faculty and student usage data. The all-important end-of-chapter material has been
significantly revised. These revisions were data-driven. Data from WileyPLUS was used to determine the questions most frequently assigned by faculty and the questions most often attempted by students. The number of popular end-of-chapter questions has been significantly increased, while infrequently assigned questions were removed. For example, the number of Application Problems has doubled, to more than 350.
Mirror problem set ‘B’ introduced for Application Problems. The Application Problems have been grouped into two sets, A and B, whose topics mirror each other, so they can be assigned separately or together for extra practice. The Application Problems are now organized by learning objective to better test students’ understanding of each objective and to make it easier for faculty to quickly identify relevant problem material.
Unique, new Work In Progress problems. A new type of problem, Work In Progress, was added, which enhances students’ critical thinking and communication skills by requiring them to correct or improve a statement about key concepts in the chapter.
Other additions and changes. The number of Discussion Questions and User Perspective Problems has been increased by roughly 20%. Finally, all Reading and Interpreting Published Financial Statements problems have been revised to reflect the most recent publicly available financial statements.
Current Accounting Standards
This edition has been revised to reflect new financial reporting standards, such as IFRS 15 (Revenue from contracts with customers) and IFRS 16 (Leases). The text covers in depth the fivestep revenue recognition model and the impact of the new IFRS 15 on sales discounts, warranties, sales returns, gift cards, and loyalty programs. Chapter 4 was completely rewritten to reflect IFRS 15, and now provides the most comprehensive revenue recognition coverage of any introductory financial accounting text.
Enhanced Coverage in Several Areas
This edition has enhanced the discussion in several areas. For example, material has been added to Chapter 6 related to the responsibility for and limitations of internal controls, while content has been added to Chapter 11 on the types of preferred shares and why they are considered to be hybrid securities. As well, the number of For Example feature boxes has increased by more than 50%, to provide students with even more real-life examples to illustrate concepts.
Enhanced Self-Assessment Opportunities
This edition has strengthened the opportunities for students to assess their mastery of the content. At the end of many sections is a new feature, Assess Your Understanding, which directs students to the Chapter End Review Problems and WileyPLUS Demonstration Problems relevant to that topic and learning objective. This makes it much easier for students to know what material they should attempt to ensure that they understand the related content. The number of Chapter End Review Problems
has more than doubled. Fully annotated solutions are provided for all of the Chapter End Review Problems, and additional Take 5 videos have been created to support students by walking them through the most difficult of these.
Specific Chapter Enhancements
The following are the notable revisions, additions, and improvements to the chapters in this second edition.
Chapter 1. Overview of Corporate Financial Reporting
• The discussion of financial accounting’s focus on external users was expanded.
Chapter 2. Analyzing Transactions and Their Effects on Financial Statements
• Content was added on dual-listed companies, Ontario Securities Commission reporting deadlines, and the requirement for external audit.
• The revenue recognition criteria were replaced with the five-step model for revenue recognition, in accordance with IFRS 15.
• The definition of what it means when an expense is incurred was enhanced.
• The graphical presentation of the qualitative characteristics from the conceptual framework was revised.
Chapter 3. Double-Entry Accounting and the Accounting Cycle
• The chapter was revised to more clearly distinguish adjusting entries from regular journal entries.
• Sample adjusting journal entries were added, together with examples from public companies.
Chapter 4. Revenue Recognition and the Statement of Income
• The chapter was completely rewritten to reflect IFRS 15.
• Information was added on the contract-based approach.
• The five-step model for revenue recognition was added, using a question-based approach to move through the model. Examples presented included the sale of goods, the provision of services, and a sale with multiple performance obligations.
• Details were added to focus on four contractual arrangements that affect the recognition of revenue: sales with right of return, warranties, consignment arrangements, and third-party sale arrangements.
• Accounts were changed to be consistent with IFRS 15 (for example, the Sales Discounts and Sales Returns and Allowances accounts were removed).
Chapter 5. The Statement of
Cash Flows
• The coverage was enhanced of options for classifying cash flows related to interest and dividends paid and received.
• The section on non-cash investing and financing activities was expanded.
• An exhibit was added outlining how changes in current asset and liability accounts impact cash flows.
• A For Example box was added providing more details on how changes in working capital items affect cash flows from operating activities.
• A For Example box was added linking the components of the statement of financial position to the statement of cash flows classification.
Chapter 6. Cash and Accounts Receivable
• Coverage of the responsibility for and limitations of internal controls was added.
• An exhibit was added to reflect the effect of journal entries flowing from the bank reconciliation.
Chapter 7. Inventory
• A section was added on the types of inventory errors and the impact they have on the financial statements.
• A learning objective was added on cost formulas under periodic inventory systems.
• The discussion of the gross margin inventory estimation method was expanded.
• Examples were added of public companies using each inventory cost formula.
Chapter 8. Long-Term Assets
• Examples were added of public companies using each depreciation method.
• Content was added regarding fully depreciated property, plant, and equipment (PP&E), idle PP&E, and PP&E held for sale.
• An exhibit was added to show how to determine the carrying amount if impairment charges are recognized.
Acknowledgements
The text’s cover photo, taken not far from my home on eastern Vancouver Island, features an arbutus tree stretching out from the shoreline of the Salish Sea in search of the sun. Arbutus trees, which are Canada’s only native broadleafed evergreen tree, are found along the coast in southern British Columbia. The arbutus tree is honoured by the Coast Salish peoples as their tree of knowledge because it knows how to find the sun. The Coast Salish also recognize it for its strength, which comes from its deep roots and strong inner core. The arbutus tree provides a wonderful metaphor for this text in a number of ways.
This edition draws strength from the roots put down by the first edition of the text. I would like to thank the students and faculty who provided feedback to improve this edition. This text’s core is also strengthened as a result of the problem material that has been drawn from Financial Accounting: A User Perspective. I am indebted to Maureen Fizzell, Donald Cherry, and Robert Hoskin for authoring
• Examples of intangible assets of public companies were expanded.
Chapter 9. Current Liabilities
• The chapter was revised to reflect the impact of the new IFRS 15 regarding revenue recognition on gift cards, customer loyalty programs, and warranties.
• The core question on gift cards and loyalty programs was split into two questions.
• The terminology used in the unearned revenues discussion was updated to reflect the terminology in the new standard.
• The core question on accounting for warranties was completely rewritten to reflect the new accounting standards.
Chapter 10. Long-Term Liabilities
• The chapter was revised to reflect the new IFRS 16, Leases.
Chapter 11. Shareholders’ Equity
• Content was added on types of preferred shares and on preferred shares as hybrid securities.
• Several new For Example boxes were added to provide more context for multiple types and classes of shares, share buybacks, initial public offerings and underwriting costs, non-voting shares, redeemable preferred shares, convertible preferred shares, and stock splits.
Chapter 12. Financial Statement Analysis
• The chapter was updated to reflect the new IFRS auditor reporting standard.
• A new learning objective was added, covering commonly used non-IFRS financial measures and other industry metrics.
such rich, diverse material. The Hoskin text was one of the books I used when I began teaching financial accounting and it helped inform and shape the way I continue to present this material. These teachings continue to be reflected in this text.
Arbutus trees require very specific environmental conditions and are only found within about 8 km of the Pacific Ocean. Any new growth also requires the right environmental conditions. I have been fortunate to work with a group of colleagues at Vancouver Island University who have supported my teaching and writing over the past 18 years. I have learned from each of them and would like to thank them, especially Gordon Holyer, Tracy Gillis, Colin Haime, Sameer Mustafa, Erin Egeland, Jeremy Clegg, Vanessa Oltmann, and Steve Purse. I have also been fortunate to work with four deans of the Faculty of Management: Ian Ross, Mike Mann, David Twynam, and Suzanne Flannigan. Each created opportunities for me to grow and provided the space in which growth could occur.
I am indebted to a number of accounting academics without whom I would never have considered authoring a text. The efforts of Sandy Hilton, especially at the Canadian Academic Accounting Association, to create venues to support teaching and learning for faculty made a significant difference to me. Sandy has also supported my case authoring efforts for years and provided excellent advice at the outset of this project. Peter Norwood has created numerous opportunities for me to broaden my participation in the academic community and also willingly shared wisdom garnered from his years as a successful author. Scott Sinclair’s feedback throughout in the development of the first edition resulted in a much improved text. I am also thankful for the advice and encouragement of Irene Gordon, Gary Spraakman, and Eldon Gardner in my earliest efforts as an author.
As a tree grows, new rings are added to its trunk. Many people have contributed growth rings to this text. Vito Di Turi, with whom I began my accounting journey some 30 years ago, made a significant contribution to this edition by developing much of the new problem material. Cecile Laurin and Maria Belanger also made noteworthy contributions to text and the end-of-chapter material. Julia Scott and Peggy Wallace both contributed to a number of chapters in the first edition of this text. Laurel Hyatt’s research work has made for interesting opening vignettes, while her talents as an editor greatly improved the readability of the text. The editorial contributions of Tania Cheffins and Belle Wong are greatly appreciated. The project management expertise of Denise Showers and the typesetting team at Aptara is also greatly valued. I consider myself so fortunate to be part of the Wiley family. Their dedicated team provided outstanding support each step of the way. I am indebted to Zoë Craig for helping frame the initial vision and for her continuous encouragement throughout the process. The editorial talents of Dela Hirjikaka added much to the text and her efforts kept the project on track, bringing the numerous parts together in a seamless fashion. I am also thankful for the support of Meaghan MacDonald, Deanna Durnford, Karen Staudinger, Anita Osborne, and Joanna Vieira.
A number of faculty have also worked hard to develop the supplements that accompany this text:
Maria Belanger, Algonquin College
Jeremy Clegg, Vancouver Island University
Rosalie Harms, University of Winnipeg
Amy Hoggard, Camosun College
Sandy Kizan, Athabasca University
Cecile Laurin, Algonquin College
Debbie Musil, Kwantlen Polytechnic University
Joel Shapiro, Ryerson University
Laura Simeoni, York University
Marie Sinnott, College of New Caledonia
Vito Di Turi, University of Ottawa (Sessional)
Many other faculty reviewed the text at various stages of development, providing advice and constructive criticism that resulted in a better offering. I would like to thank them for their insights.
Manuscript development stage (first edition)
Ibrahim Aly, Concordia University
George Boland, Queen’s University
Else Grech, Ryerson University
Sohyung Kim, Brock University
Jennifer Li, Brock University
Anne Macdonald, Simon Fraser University
Robert Madden, St. Francis Xavier University
Julie McDonald, Ryerson University
Jaime Morales, Trent University
Peter Norwood, Langara College
Sandy Qu, York University
Scott Sinclair, University of British Columbia
Sara Wick, University of Guelph
First edition
Robert Campbell, John Molson School of Business, Concordia University
Brenda Collings, University of New Brunswick Saint John
Erin Egeland, Vancouver Island University
Maureen Fizzell, Simon Fraser University (Burnaby Campus)
Steve Gibson, Simon Fraser University (Burnaby Campus)
Len Hostin, McMaster University
Srinivas Inguva, George Brown College
Robert Madden, St Francis Xavier University
Just as trees use the magic of photosynthesis to transform light energy into chemical energy, a magical process takes place in classrooms at campuses the world over. Much of what is best about this product has resulted from such classroom interactions. The echoes of the hundreds of introductory accounting classes and seminars I have taught over the past 18 years can be heard throughout the pages of this text. So much of what I have learned about presenting this material is thanks to the thousands of students from these classes. I am so thankful for the shared learning experience.
The strength of a tree is provided by its heartwood, so it is no surprise that, for this text, strength came from the people closest to my own heart. I am grateful for a wonderful collection of family and friends. Two key supports were my mother, Bernette, and my sister, Faith. My children, Jacob and Erin, have been a constant source of inspiration and have patiently dealt with me disappearing into my office for long hours of writing and have tolerated the working edition of the text as a constant presence wherever we are. I am most indebted to my partner and best friend, Caroline. She has always encouraged me to take on new challenges, providing constant and unwavering support. Caroline has inspired so much of what is wonderful in my life and this book is just another example of that.
I hope that the text will help you to develop your own strong understanding of financial accounting. Feedback and suggestions for improving future editions are welcome. Please email them to BurnleyAuthor@gmail.com.
CHRIS BURNLEY
Vancouver Island University
January 2018
Contents
1 Overview of Corporate Financial Reporting
1-1
Dollar Store Business Is No Small Change 1-1
Introduction to Financial Accounting 1-3
What Is Financial Accounting? 1-3
Users and Uses of Financial Accounting 1-4
Who Needs an Understanding of Financial Accounting and Why? 1-4
Forms of Business Organization 1-9
What Is a Corporation? 1-9
What Diferentiates a Corporation from Other Forms of Business? 1-10
Activities of a Business 1-10
What Are the Three Categories of Business Activities? 1-10
What Are Examples of Financing Activities? 1-11
What Are Examples of Investing Activities? 1-12
What Are Examples of Operating Activities? 1-12
Financial Reporting 1-13
What Information Is Included in a Set of Financial Statements? 1-13
What Is the Reporting Objective of the Statement of Income? What Does It Include? 1-14
What Is the Reporting Objective of the Statement of Changes in Equity? What Does It Include? 1-17
What Is the Reporting Objective of the Statement of Financial Position? What Does It Include? 1-18
What Is the Reporting Objective of the Statement of Cash Flows? What Does It Include? 1-22
What Type of Information Is in the Notes to a Company’s Financial Statements? 1-24
2 Analyzing Transactions and Their Efects
on Financial Statements 2-1
A Growing Appetite for Financial Transparency 2-1
Introduction 2-3
Accounting Standards 2-3
What Are Accounting Standards? 2-3
Do All Canadian Companies Use the Same Accounting Standards? 2-3
Who Sets the Accounting Standards Used in Canada? 2-4
Qualitative Characteristics of Financial Information 2-5
How Do the Standard Setters Determine What Constitutes Useful Financial Information? 2-5
Accrual Versus Cash Basis of Accounting 2-8
What Is the Diference between the Cash Basis of Accounting and the Accrual Basis of Accounting? 2-9
The Accounting Equation Template Approach 2-10
What Is the Accounting Equation Template Approach to Recording Transactions? 2-10
Using the Accounting Equation Template Approach to Analyze and Record Transactions 2-12
How Is the Accounting Equation Used to Analyze and Record Transactions? 2-12
What Are the Limitations of the Accounting Equation Template Approach? 2-24
Financial Statements 2-26
How Do We Know if the Company Was Profitable during the Accounting Period? 2-26
How Can We Tell if the Equity Position of Shareholders Changed during the Accounting Period? 2-27
How Do We Determine the Company’s Financial Position at the End of the Accounting Period? 2-27
How Can We Tell if the Company’s Cash Position Changed during the Accounting Period? 2-28
Using Ratios to Analyze Financial Statements 2-30
How Do We Determine the Company’s Profit Margin? 2-31
How Do We Determine How Efective the Company Has Been at Generating a Return on Shareholders’ Equity? 2-31
How Do We Determine How Efective the Company Has Been at Generating Profits Using Its Assets? 2-32
3 Double-Entry Accounting and the Accounting Cycle
3-1
Balancing the Books When Bartering 3-1
The Double-Entry System 3-3
How Does the Double-Entry Accounting System Work and How Does It Overcome the Limitations of the Template Method? 3-3
The Normal Balance Concept 3-4
What Is the Normal Balance Concept and How Is It Used? 3-4
Understanding the Accounting Cycle 3-7
What Are the Steps in the Accounting Cycle? 3-7
The Chart of Accounts 3-8
What Is the Chart of Accounts? 3-8
Can Companies Change Their Chart of Accounts and What Are the Implications If They Do? 3-10
Opening Balances 3-10
What Is the Diference between Permanent and Temporary Accounts? 3-10
Transaction Analysis and Recording 3-11
How Are Transactions Identified? 3-11
How Are Transactions Recorded in the General Journal? 3-11
Why Are Transactions Also Recorded in the General Ledger? 3-18
What Is the Purpose of Preparing a Trial Balance? 3-19
Adjusting Entries 3-21
What Are Adjusting Entries and Why Are They Necessary? 3-21
What Is the Purpose of Preparing an Adjusted Trial Balance? 3-26
Preparing Financial Statements and Closing Entries 3-26
What Are Closing Entries and Why Are They Necessary? 3-26
4 Revenue Recognition and the
Statement of Income 4-1
Expanding the Cast to Bring in the Cash 4-1
Revenue and Its Significance 4-2
What Is Revenue and Why Is It of Significance to Users? 4-3
Why Is Understanding How a Company Recognizes Revenue of Significance to Users? 4-4
Revenue Recognition 4-4
When Are Revenues Recognized? 4-5
Other Revenue Recognition Issues 4-13
How Do the Right of Returns, Warranties, Consignment, and Third-Party Sale Arrangements Afect Revenue Recognition? 4-13
Statement of Income Formats 4-15
How Does a Single-Step Statement of Income Difer from a Multi-Step Statement of Income? 4-16
Statement of Comprehensive Income 4-18
What Is Comprehensive Income and How Does It Difer from Net Income? 4-18
Presentation of Expenses by Nature or by Function 4-19
How Does a Statement of Income Presenting Expenses by Function Difer from One Presenting Expenses by Nature of the Items? 4-19
Financial Statement Analysis 4-21
What Is Meant by Earnings per Share, and How Is It Calculated? 4-22
5 The Statement of Cash Flows
The Dash for Cash 5-1
Introduction 5-3
How Is “Cash” Defined? 5-3
Why Is the Statement of Cash Flows of Significance to Users? 5-4
Diferences between the Statement of Cash Flows and the Statement of Income 5-5
How Does the Statement of Cash Flows Difer from the Statement of Income? 5-5
Understanding the Statement of Cash Flows 5-7
What Are the Categories of Cash Flows Presented in the Statement of Cash Flows and What Are Typical Transactions Included in Each Category? 5-7
Why Is So Much Significance Placed on Cash Flows from Operating Activities? 5-8
What Is the Diference between the Direct and Indirect Methods of Preparing Cash Flows from Operating Activities? 5-9
What Are the Options for Classifying Cash Flows Related to Interest and Dividends Paid and Received? 5-10
Are There Investing and Financing Activities That Do Not Appear on the Statement of Cash Flows? 5-11
Preparing the Statement of Cash Flows Using the Indirect Method 5-12
How Is a Statement of Cash Flows Prepared Using the Indirect Method for Operating Activities? 5-12
Preparing the Statement of Cash Flows Using the Direct Method 5-22
How Is a Statement of Cash Flows Prepared Using the Direct Method for Operating Activities? 5-22
Interpreting Cash Flow Information 5-25
How Can the Information Presented in a Statement of Cash Flows Be Used to Manage a Company? 5-25
What Can Cash Flow Patterns Tell Us? 5-27
Financial Statement Analysis 5-29
How Do We Determine What Portion of a Company’s Liabilities Could Be Met with Cash Flows from Operating Activities? 5-29
How Do We Determine How Much Net Free Cash Flow a Company Generates? 5-30
6 Cash and Accounts Receivable
Will That Be Cash or Credit? 6-1
Introduction 6-3
5-1
6-1
Why Are Cash and Accounts Receivable of Significance to Users? 6-3
Cash 6-4
What Is Included in the Definition of “Cash”? 6-4
At What Amount Is Cash Reflected on the Statement of Financial Position? 6-4
Internal Control 6-4
Who Is Responsible for an Organization’s Internal Controls? 6-4
What Are the Main Principles of Internal Control? 6-5
What Are the Limitations of Internal Control? 6-7
Bank Reconciliation 6-7
What Is the Purpose of a Bank Reconciliation and Why Must It Be Prepared? 6-7
How Is a Bank Reconciliation Prepared? 6-8
Accounts Receivable 6-12
What Are Accounts Receivable? 6-12
Why Do Companies Sell on Account? 6-12
Are There Any Additional Costs from Selling on Account? 6-13
Bad Debts 6-14
At What Amount Are Accounts Receivable Reflected on the Statement of Financial Position? 6-14
The Allowance Method 6-16
What Is the Allowance Method of Accounting for Bad Debts? 6-16
Estimating Bad Debts under the Allowance Method 6-19
How Are Bad Debts Estimated under the Allowance Method? 6-19
The Direct Writeof Method 6-23
What Is the Direct Writeof Method and When Is It Acceptable to Use It? 6-23
Cash-to-Cash Cycle 6-24
How Do Companies Shorten Their Cash-to-Cash Cycle? 6-24
Financial Statement Analysis 6-26
What Is Liquidity and How Is It Assessed? 6-26
How Efective Has the Company Been at Collecting Its Accounts Receivable? 6-28
7 Inventory 7-1
Mini Cars; Maxi Inventories 7-1
Introduction 7-3
What Is Inventory? 7-3
Why Is Inventory of Significance to Users? 7-4
Types of Inventory 7-5
What Are the Major Classifications of Inventory? 7-5
What Goods Are Included in a Company’s Inventory? 7-6
Inventory Systems 7-7
What Is a Periodic Inventory System? 7-8
What Is a Perpetual Inventory System? 7-9
What Are the Key Distinctions between Periodic and Perpetual Inventory Systems? 7-11
How Does Management Decide Which Inventory System to Use? 7-11
Cost Formulas 7-13
What Costs Are Included in Inventory? 7-13
What Are Cost Formulas and Why Are They Necessary? 7-13
How Are Cost of Goods Sold and Ending Inventory
Determined Using the Specific Identification, Weighted-Average, and First-In, First-Out Cost Formulas under a Perpetual Inventory System? 7-16
How Do Companies Determine Which Cost Formula to Use? 7-18
Inventory Valuation 7-19
At What Value Is Inventory Reflected on the Statement of Financial Position? 7-20
How Is the Lower of Cost or Net Realizable Value Applied to Inventory? 7-21
What Types of Inventory Valuation Errors Can Happen and What Impact Do They Have on the Financial Statements? 7-21
Gross Margin 7-22
What Is Gross Margin and Why Is It a Key Measure? 7-22
Internal Controls and Inventory 7-23
What Principles of Internal Control Can Be Applied to Inventory? 7-24
Financial Statement Analysis 7-25
How Ofen Does the Company Sell through Its Inventory? 7-25
How Many Days Did It Take to Sell through the Company’s Inventory? 7-26
How Can Inventory Amounts Be Estimated? 7-27
Appendix: Inventory Cost Formulas under the Periodic Inventory System 7-28
How Are Cost of Goods Sold and Ending Inventory Determined Using the Specific Identification, WeightedAverage, and First-In, First-Out Cost Formulas under a Periodic Inventory System? 7-28
8 Long-Term Assets
8-1
A Canadian Icon’s Long-Term Assets 8-1
Introduction 8-3
What Are the Various Types of Long-Term Assets? 8-3
Why Are Long-Term Assets of Significance to Users? 8-4
Valuation of Property, Plant, and Equipment 8-5
At What Amount Are Property, Plant, and Equipment Reflected on the Statement of Financial Position? 8-5
What Is Included in “Cost”? 8-6
What Happens When a Company Purchases Multiple Assets for a Single Price? 8-6
How Do We Account for Costs Subsequent to Purchase? 8-7
Can a Company Carry Property, Plant, and Equipment at Their Fair Values? 8-8
Depreciation 8-8
Why Do We Depreciate Property, Plant, and Equipment? 8-8
Depreciation Methods 8-9
What Are the Methods Used to Depreciate Property, Plant, and Equipment? 8-9
How Do We Choose a Depreciation Method? 8-16
How Do We Record Depreciation Expense? 8-16
Does an Asset’s Carrying Amount Tell Me What It Is Worth? 8-17
How Do We Determine Depreciation for Partial Periods? 8-17
Is Depreciation Expense Recorded Every Period for Each PP&E Asset? 8-18
Does the Choice of Depreciation Method Afect Corporate Income Taxes? 8-18
Changes in Depreciation Methods 8-19
Can We Change Depreciation Estimates and Methods? 8-19
Impairment 8-22
What Does It Mean If an Asset Is Impaired? 8-22
Disposal of Property, Plant, and Equipment 8-23
How Do We Account for Disposals of Property, Plant, and Equipment? 8-23
Intangible Assets 8-25
What Are Intangible Assets? 8-25
At What Amount Are Intangible Assets Reflected on the Statement of Financial Position? 8-27
How Is Accounting for Intangible Assets Diferent from Accounting for Property, Plant, and Equipment? 8-28
Goodwill 8-28
What Is Goodwill? 8-28
At What Amount Is Goodwill Reflected on the Statement of Financial Position? 8-30
How Is Goodwill Treated Diferently from Other Long-Term Assets? 8-30
Financial Statement Analysis 8-31
How Do We Determine the Relative Age of the Company’s Long-Term Assets? 8-31
How Do We Assess How Efectively the Company Has Used Its Long-Term Assets? 8-32
9 Current Liabilities
9-1
Customer Loyalty Is in the Books 9-1
Introduction 9-3
Why Is the Distinction between Current and Non-Current Liabilities of Significance to Users? 9-3
Valuation Methods 9-4
At What Amount Are Current Liabilities Reflected on the Statement of Financial Position? 9-4
Current Liabilities Arising from Transactions with Lenders 9-4
What Current Liabilities Arise from Transactions with Lenders? 9-5
Current Liabilities Arising from Transactions with Suppliers 9-8
What Current Liabilities Arise from Transactions with Suppliers? 9-8
Why Are Accounts Payable Sometimes Considered “Free Debt”? 9-8
Current Liabilities Arising from Transactions with Customers 9-9
What Current Liabilities Arise from Transactions with Customers? 9-9
How Are Unearned Revenues Accounted for? 9-9
How Are the Liabilities Related to Gif Cards Accounted for? 9-11
How Are the Liabilities Related to Loyalty Programs Accounted for? 9-12
How Are Warranties Accounted for? 9-14
Current Liabilities Arising from Transactions with Employees 9-16
What Current Liabilities Arise from Transactions with Employees? 9-16
How Are Payroll Costs Accounted for? 9-17
Why Are a Company’s Wage Costs Greater Than What It Pays Its Employees? 9-19
Current Liabilities Arising from Transactions with the Government 9-20
What Current Liabilities Arise from Transactions with Government? 9-20
When Are a Company’s Taxes Due? 9-20
Current Liabilities Arising from Transactions with Shareholders 9-21
What Current Liabilities Arise from Transactions with Shareholders? 9-21
Financial Statement Analysis 9-21
How Do We Determine How Long a Company Takes to Pay Its Suppliers? 9-22
10 Long-Term Liabilities
Avoiding Pension Turbulence 10-1
Introduction 10-3
10-1
Why Are Long-Term Liabilities of Significance to Users? 10-3
Long-Term Liabilities Arising from Transactions with Lenders 10-4
What Long-Term Liabilities Arise from Transactions with Lenders? 10-4
How Are Long-Term Loans and Mortgages Accounted for? 10-4
What Are Bonds and How Do They Difer from Long-Term Loans? 10-8
How Are Bonds Priced in the Marketplace? 10-10
How Does the Pricing of Bonds Afect a Company’s Interest Expense? 10-12
Long-Term Liabilities Arising from Transactions with Other Creditors 10-14
What Long-Term Liabilities Arise from Transactions with Other Creditors? 10-14
Why Do Companies Lease Capital Assets? 10-14
How Are Leases Accounted for? 10-15
Long-Term Liabilities Arising from Transactions with Employees 10-16
What Long-Term Liabilities Arise from Transactions with Employees? 10-16
What Are the Diferences between Defined Contribution, Defined Benefit, and Hybrid Pension Plans? 10-17
What Are Other Post-Employment Benefits? 10-20
Long-Term Liabilities Arising from Diferences between Accounting Standards and the Income Tax Act 10-21
What Long-Term Liabilities Arise as a Result of Diferences between Accounting Standards and the Income Tax Act? 10-21
Commitments and Guarantees 10-22
How Are Contractual Commitments and Guarantees Reflected in the Financial Statements? 10-22 Contingencies 10-23
What Are Contingent Liabilities and How Are They Accounted for? 10-23
Financial Statement Analysis 10-25
How Do Users Assess a Company’s Degree of Leverage? 10-25
How Do Users Assess a Company’s Ability to Service Its Long-Term Debt Obligations? 10-27
11 Shareholders’ Equity
11-1
Investors Warm up to Owning Shares in Canada Goose 11-1
Introduction 11-3
Why Is Shareholders’ Equity of Significance to Users? 11-3
The Shareholders’ Equity Section 11-3
What Is Included in the Shareholders’ Equity Section of the Statement of Financial Position? 11-3
Types of Shares 11-6
What Types of Shares Is a Company Allowed to Issue? 11-6
What Is the Diference between Authorized, Issued, and Outstanding Shares? 11-7
Why Would a Company Repurchase Its Own Shares? 11-7
What Are the Diferences between Common and Preferred Shares? 11-8 Dividends 11-17
Do Companies Have to Pay Dividends? 11-17
What Are the Diferent Dates Involved in Declaring and Paying a Dividend? 11-18
How Are the Declaration and Payment of Dividends Recorded? 11-19
What Is the Diference between a Cash Dividend and a Stock Dividend? 11-20
Stock Splits 11-23
What Is a Stock Split? 11-23
Why Would a Company Split Its Shares? 11-23
Financial Statement Analysis 11-25
What Is the Price/Earnings Ratio? 11-25
What Other Ratios Measure the Return the Shareholders Are Earning? 11-26
Financing with Equity 11-28
What Are the Advantages and Disadvantages of Financing with Equity? 11-28
12 Financial Statement Analysis
Student Stock Analysts Try to “Beat the Street” 12-1
12-1
Introduction 12-3
What Is Financial Statement Analysis? 12-3
What Is the Process for Analyzing Financial Statements? 12-4
The Contexts for Financial Statement Analysis 12-5
What Are the Common Contexts for Financial Statement Analysis? 12-5
Why Is an Understanding of Context Essential to the Analysis? 12-5
Understanding the Business 12-6
Why Is It Essential to Understand the Business Being Analyzed? 12-6
Business Information 12-7
What Information Is the Financial Statement Analysis Based on and Where Is It Found? 12-7
Financial Statement Analysis Perspectives 12-11
What Is the Diference between Retrospective and Prospective Analysis? 12-11
What Is the Diference between Trend Analysis and Cross-Sectional Analysis? 12-11
Financial Statement Analysis Techniques 12-16
What Is Common-Size Analysis? 12-16
How Is Ratio Analysis Used to Analyze Financial Statements? 12-17
What Are the Common Categories of Ratios? 12-18
Ratio Analysis 12-21
What Liquidity Ratios Are Commonly Used? 12-21
What Activity Ratios Are Commonly Used? 12-22
What Solvency Ratios Are Commonly Used? 12-26
What Profitability Ratios Are Commonly Used? 12-29
What Equity Analysis Ratios Are Commonly Used? 12-31
Limitations of Ratio Analysis 12-35
What Are the Limitations of Ratio Analysis? 12-35
Use of Non-IFRS Financial Measures and Other Industry Metrics 12-36
What Non-IFRS Financial Measures and Industry Metrics Are Commonly Used by Investors? 12-36
Why Should We Be Cautious When Using Non-IFRS Financial Measures and Industry Metrics? 12-37
APPENDIX A Specimen Financial Statements: Dollarama Inc. A-1
GLOSSARY / COMPANY INDEX / SUBJECT INDEX
Overview of Corporate Financial Reporting
Dollar Store Business Is No Small Change
When Salim Rossy opened a general store in Montreal in 1910, he financed it with his earnings from peddling items like brooms and dishcloths in the countryside around Montreal. By the time his grandson Larry took charge in 1973, S. Rossy Inc. had grown into a chain of 20 five-anddime stores, with most items priced at either 5 or 10 cents. In 1992, the company opened its first Dollarama store, selling all items for $1. Today, the business, now called Dollarama Inc., is Canada’s largest dollar store chain. It operates more than 1,000 stores in every province and now sells goods between $1 and $4.
How do large companies such as Dollarama finance growth?
Like many companies that reach a certain size, Dollarama became a public company, issuing shares that trade on the Toronto Stock Exchange (TSX). The company’s initial public offering, in 2009, raised $300 million, which was used to open new stores. The company’s growth has been steady ever since. By 2011, it had more locations than Canadian Tire, and recently it has opened an average of one new store a week. It plans to eventually operate 1,400 locations across Canada. At the end of its 2017 fiscal year (as at January 29, 2017), Dollarama had raised more
than $420 million from issuing shares, and it had more than $2.9 billion in sales that year.
Company management is continually looking for ways to increase sales and reduce costs. It recently increased the maximum price of items from $3 to $4, widening the number of suppliers it can use and boosting the types of products it can carry. “Customers are responding positively to the offering,” said Neil Rossy, who took over from his father Larry as Chief Executive Officer in 2016.
Shareholders and others, such as banks and suppliers, use a company’s financial statements to see how the company has performed and what its future prospects might be. Shareholders use them to make informed decisions about things such as whether to sell their shares, hold onto them, or buy more. Creditors use financial statements to assess a company’s ability to service its debts (pay interest and repay principal), while suppliers may use them to determine whether to allow the company to purchase on credit. Companies communicate all this information through financial reporting, and the tool used to prepare financial information is accounting.
Whether or not Dollarama achieves the increased revenues and profits it hopes for by selling higher-priced items will be reported in the company’s future financial statements. These financial statements will tell the story of whether Dollarama got the best bang for its buck.1
CORE QUESTIONS LEARNING OBJECTIVES
If you are able to answer the following questions, then you have achieved the related learning objectives.
Introduction to Financial Accounting
• What is financial accounting?
Users and Uses of Financial Accounting
• Who needs an understanding of financial accounting and why?
Forms of Business Organization
• What is a corporation?
• What diferentiates a corporation from other forms of business?
Activities of a Business
• What are the three categories of business activities?
• What are examples of financing activities?
• What are examples of investing activities?
• What are examples of operating activities?
Financial Reporting
• What information is included in a set of financial statements?
• What is the reporting objective of the statement of income? What does it include?
• What is the reporting objective of the statement of changes in equity? What does it include?
• What is the reporting objective of the statement of financial position? What does it include?
• What is the reporting objective of the statement of cash flows? What does it include?
• What type of information is in the notes to a company’s financial statements?
Afer studying this chapter, you should be able to:
1. Define financial accounting and understand its relationship to economic decision-making.
2. Identify the main users of financial accounting information and explain how they use this information.
3. Describe the major forms of business organization and explain the key distinctions between them.
4. Explain the three categories of business activities and identify examples of transactions related to each category.
5. Identify and explain the content and reporting objectives of the four basic financial statements and the notes to the financial statements.
Introduction to Financial Accounting
LEARNING OBJECTIVE 1
Define financial accounting and understand its relationship to economic decisionmaking.
The opening story is an example of how a large company grows. Whether a business is borrowing money for a start-up or expansion, restructuring the organization, or deciding whether to purchase or lease equipment, it needs to have accounting information to make the best decisions. You, too, will use accounting information to help you make decisions, whether it’s determining if you should buy a company’s shares, apply for a job there, or enter into a contract with it.
What Is Financial Accounting?
Financial accounting is the process by which information on the transactions of an organization is captured, analyzed, and used to report to decision makers outside of the organization’s management team. Financial accounting is sometimes referred to as external financial reporting due to its focus on providing accounting information to external decision makers. These external decision makers are often referred to as financial statement users and include the owners (normally referred to as investors) and those who have lent money to the organization (normally referred to as creditors). The primary purpose of financial accounting information is to aid these users in their economic decision-making relative to the organization. Because these users are generally outside of the organization and are not involved in its day-to-day operations, the financial accounting information they receive is often their only “window” into the organization.
Users inside the organization (management) also use financial accounting information, but they generally require the information at a different level of detail. For example, managers in a national retail chain may need information for a particular store rather than for the organization as a whole. Managers may need different information altogether, such as information needed to develop forward-looking budgets rather than to report on past transactions. It is important to note that management has access to all of the organization’s financial information, including information that is never shared with those outside of the organization. This information is known as managerial accounting and will be the basis for another course in your business studies.
Management prepares two broad types of accounting reports:
• Reports for internal use only (for use by management): This is known as managerial accounting. Its purpose is to inform decision-making.
• Reports for external use (for use by others outside the organization): This is known as financial accounting. Its purpose is to help external users make decisions.
Financial accounting, the focus of this textbook, can be as simple as determining the daily sales of a food truck or as complex as recording and reporting on the economic condition of your university, a multinational corporation, or the Government of Canada. All of these entities need to know economic information in order to continue to operate efficiently and effectively. Financial accounting provides vital financial information that enables people and organizations to make decisions. Because it is very likely that you will be a financial statement user in some way, it is important that you have at least a basic understanding of what financial accounting is (and is not), what it is trying to accomplish, and how it does so.
The focus of this book is the financial accounting information produced by profit-oriented organizations, although we will occasionally refer to not-for-profit organizations or governments. We will concentrate on the financial statements, which are management’s reports to the company’s owners that are produced at the end of each accounting period, such as every
quarter or every year. The annual financial statements are included in the company’s annual report together with the management discussion and analysis (MD&A) of the company’s results for the year. The annual report is made available to the company’s owners, but many other parties, such as lenders, financial analysts, credit-rating agencies, securities regulators, and taxing authorities, also use it.
Users and Uses of Financial Accounting
LEARNING OBJECTIVE 2
Identify the main users of financial accounting information and explain how they use this information.
Who Needs an Understanding of Financial Accounting and Why?
Before we answer these questions, let’s take some time to think a little about the game of hockey. (Yes, hockey. After all, what’s a Canadian textbook without a hockey reference?) Whether you have lived in Canada your whole life or you are here studying from some other part of the world, chances are good that you have seen a professional hockey game on television or perhaps even in person. During the game, the TV commentary or the conversations of those around you would have included terms like icing, charging, slashing, five-hole, hash marks, neutral zone, and so on. These would have been confusing terms the first time you heard them, but once they were explained to you, your ability to follow the game and understand it at a deeper level would have improved. This is the same with financial accounting. Through the text’s 12 chapters we will learn the language of financial accounting and how to interpret financial accounting information so you can come away with a deeper understanding of the subject.
So, let’s rephrase our opening question and think about “who needs to understand the rules of professional hockey?” Many groups likely come to mind fairly quickly, including:
• players (including their agents and players’ union)
• coaches and general managers
• referees, linesmen, and off-ice officials
• fans
• TV commentators, arena announcers, and sports journalists
• league officials
• team owners
• suppliers, advertisers, and landlords
We can call these people stakeholders because they have a stake in understanding hockey. Now, let’s take this list of hockey stakeholders and find the parallel business stakeholders who would have a similar stake in a business, as shown in Exhibit 1.1
Now, let’s consider some of the questions that each of the stakeholders in a business may be trying to answer about that business that would require an understanding of financial accounting, as shown in Exhibit 1.2
These groups of business stakeholders are often known as financial statement users. Throughout this book, we will be looking at the information needs of many of these users and discussing how they use financial accounting information in making a variety of decisions. The breadth of this list of users illustrates that no matter which path you take in your business
EXHIBIT 1.1
Hockey Stakeholders
Parallel Business Stakeholders
Players, including their agents and players’ union
Coaches and general managers
Employees, unions
Management
Referees, linesmen, off-ice officialsAuditors, federal and provincial government departments, legislators
Fans
Announcers, TV analysts, sports journalists
League officials
Team owners
Suppliers, advertisers, landlords
Employees, unions
Management
Auditors, federal and provincial government departments, legislators
Potential investors, customers
Stock analysts, brokers, financial advisors, business reporters
Stock exchange regulators
Potential investors, customers
Stock analysts, brokers, financial advisors, business reporters
Stock exchange regulators
Shareholders, board of directors
Creditors, suppliers, landlords
Potential Questions They May Be Trying to Answer about the Business
Is the business profitable? Will I earn a bonus this year? Could the company afford to negotiate increased wages? Is the company pension plan in decent shape?
How do this year’s sales compare with last year’s? How do they compare with the budget? Are we maintaining our profit margins on certain product lines? How much do we owe our employees and suppliers?
Has the company presented its financial information fairly?
How does the company’s financial information compare with the information submitted for taxation or payroll purposes?
What are the long-term prospects for this company? Has the management team done a reasonable job? Will this company be around to honour its warranties?
What are the company’s trends? What are the prospects for this company? How has this company performed relative to expectations?
Has the company complied with the financial reporting standards and listing requirements?
Shareholders, board of directorsHas the company generated a sufficient return on our investment? How effectively has management used the resources at their disposal? Does the company generate enough income to be able to pay dividends?
Creditors, suppliers, landlords
Should we extend credit to this company? Is this a credible and successful company that we want to attach our brand to? Should we enter into a lease with this company?
Similarities between Hockey Stakeholders and Business Stakeholders
EXHIBIT 1.2
Questions That Stakeholders in a Business May Be Asking
EXHIBIT 1.3
Users of Financial Statement Information
studies, having a basic understanding of accounting information will be essential to business success or could be a job requirement. As we move through the chapters, try to see yourself in one or more of these roles and think about the ways in which you can make use of the accounting information that you will no doubt come across.
The primary goal of this book is to help you become an intelligent user of accounting information by enhancing your ability to read and understand corporate financial statements. You may become a manager, accountant, banker, or financial analyst, and even if you do not end up working directly in the finance industry, you will invest in the shares or bonds of a company at some point in your life. If you work in a company, whether in sales, human resources, or other areas, your decisions will likely have an impact on what is reported to owners. Whatever your business role, you will make decisions about companies, such as whether to invest in their shares, lend them money, or sell them goods or services on credit. In making these decisions, it will be important for you to understand the information that is presented in corporate financial statements. You must know what each piece of information tells you about the company, but also what it does not tell you. You should also understand that some information that is useful in making certain decisions is not contained in the financial statements.
This book has been written for a broad readership, understanding that many of you will play multiple roles as owners (shareholders), creditors, and managers of companies. It starts with the assumption that you know little or nothing about accounting. It also assumes that you are not training to be an accountant, although that may be your objective. Therefore, this book does not emphasize accounting procedures. Instead, it emphasizes the underlying concepts of accounting and the analysis of financial statements. However, it is not really possible to have a knowledgeable understanding of the end result of the accounting process without first having an overall view of how the accounting system works. For this reason, the first three chapters present the basic mechanics of the accounting system. The remaining chapters are then devoted to more detailed accounting issues and concepts, and to a more in-depth analysis of financial statements.
We will now explore the financial statement users in more detail. Exhibit 1.3 lists the various financial statement users, categorizing them as either internal or external users.
Internal users:
Management
External users:
Shareholders, the board of directors, and potential investors
Creditors (for example, financial institutions and suppliers)
Regulators (for example, a stock exchange)
Taxing authorities (for example, the Canada Revenue Agency)
Other corporations, including competitors
Securities (stock) analysts
Credit-rating agencies
Labour unions
Journalists
Since the focus of financial accounting is reporting to external users, let’s look at these users and their information needs in greater detail.
Shareholders, the Board of Directors, and Potential Investors
A company is owned by its shareholders. There may be a single shareholder in the case of a private company or many thousands of shareholders in the case of a public company. We will discuss the distinctions between private and public companies a little later in the chapter, so for now it is just important to understand that companies are owned by their shareholder(s). In
situations where there are numerous shareholders, they elect a board of directors to represent their interests. The board of directors is given the responsibility of overseeing the management team that has been hired to operate the company.
The board of directors, individual shareholders, and potential investors all require information to enable them to assess how well management has been running the company. Just like hockey fans look at the arena scoreboard to see how their team is doing in terms of the score, shots on goal, and so on, stakeholders in a business look at a company’s financial reports to determine how it’s doing in a number of areas. Business stakeholders want to make decisions about buying more shares or selling some or all of the shares they already own (similar to a hockey team’s general manager deciding whether to acquire a star player or trade an underperforming one). They will analyze the current share price (as reflected on the stock exchange) and compare it with the original price that they paid for the shares. Are the shares now worth more or less? They will also be comparing the share price with the company’s underlying value, which is reflected in the financial statements and other sources of information they have about the company.
Individual shareholders will also want to assess whether the current board of directors have effectively carried out their oversight role. They will seek to answer questions such as:
• Is the company heading in the right direction (that is, has the strategic direction approved by the board resulted in increased sales, profits, and so on)?
• Is it making decisions that result in increased value to the shareholders?
• Is the company generating a sufficient return on the resources invested in it by the shareholders?
Creditors
Creditors are those who lend money or otherwise extend credit to a company rather than invest in it directly as investors do. There are two major groups of creditors:
1. Financial institutions and other lenders
2. Suppliers, employees, and the various levels of government
Financial institutions, such as banks and credit unions, lend money to companies. They do so seeking to generate a return on these loans in the form of interest. Of course, the lenders also want to ensure that the money they lend out will eventually be repaid (that is, the loan principal will be repaid). Loans can either be short-term or extend over several years. These lenders need financial accounting information to assess the company’s ability to service the loan. One of the ways this is done is by looking at the cash flows the company generates through its operations. They are also generally interested in the amount of the company’s inventory, equipment, buildings, or land, because these may be pledged as security by the borrowing company in the event that it cannot repay the loan. Large companies also enter into long-term borrowing arrangements by issuing corporate bonds. Rather than borrowing from a single lender, companies that issue bonds borrow from many lenders. Nevertheless, these lenders are also concerned about the company’s ability to service the debt (pay interest and repay principal) over the term of the bond, and their financial accounting information needs are similar to those of other lenders.
The other group of creditors includes suppliers, employees, and various levels of government. These groups often sell goods or provide services prior to receiving payment. For example, a supplier may agree to sell goods or provide services to a company and agree to wait 30 days for payment. Employees are another common creditor as they normally work for the company and then receive payment after the fact, such as at the end of every two weeks or at the end of a month. Different levels of government may also be creditors of a company as they wait to receive tax payments or payroll deduction amounts. These users may focus on the amount of cash in the company because they are concerned about being paid.
Regulators
The regulators who are interested in financial statements are numerous. For example, the federal and provincial governments have regulations related to how companies report their
financial information and are interested in ensuring that these regulations are followed. The stock exchanges, on which the shares of public companies are traded, have regulations about the timing and format of information that companies must convey to them and to investors. Companies not complying with these regulations can be delisted, meaning their shares cease to trade on the exchange, which greatly affects their ability to raise capital.
For Example
Canadian Bioceutical Corporation, an Ontario company with two medical cannabis enterprises in Arizona, is a publicly traded company whose shares trade on the Toronto Stock Exchange (TSX). It announced on July 25, 2017, that it had applied to the Ontario Securities Commission, the government regulator that oversees publicly traded companies, for a management cease trade order because the company was not going to be able to meet the July 31, 2017, filing deadline for its audited financial statements for the year ended March 31, 2017. The company noted that it could not meet the filing deadline due to delays caused by integrating the accounting and operating systems of newly acquired subsidiaries. Delays were also caused by having to translate the accounting records of these companies from the accounting standards used by U.S. public companies (called U.S. generally accepted accounting principles) to the accounting standards used by Canadian public companies (called International Financial Reporting Standards). As a result of the cease trade order, restrictions were placed on the trading of the company’s shares on the TSX.
Taxing Authorities
The Canada Revenue Agency (CRA) is the federal taxing authority in Canada and is responsible for federal tax collection. Corporate taxes are primarily based on taxable income, which is calculated based on accounting net income. As such, the CRA is another key user of a company’s financial accounting information.
Other Users
Additional users of financial statement information include other companies, securities analysts, credit-rating agencies, labour unions, and journalists. Other companies may want information about the performance of a company if they are going to enter into contracts with it. If it is a direct competitor, they may seek information that will help assess the competitor’s strength and future plans. Securities analysts and credit-rating agencies use the financial statements to provide information about the strengths and weaknesses of companies to people who want to invest. Labour unions need to understand the company’s financial health in order to negotiate labour contracts with management. Companies often give journalists news releases that disclose financial information such as expected earnings. The journalists may refer to the actual financial statements to validate the information they were given and to supplement the original information.
It is important to understand that all of these users are using the same set of financial statements in spite of the diversity of their information needs. The bodies that establish the international and domestic standards for financial reporting are aware of all of these users, but have taken the position that they will emphasize the needs of investors and creditors in the determination of standards. As such, many pieces of information that particular users may want cannot be found in the financial statements, and these users must look to other sources of information as well.
The types of financial information gathered and made available to stakeholders vary depending on the form of organization a business has, which we discuss next.
Heath Korvola/Getty Images
Forms of Business Organization
LEARNING OBJECTIVE 3
Describe the major forms of business organization and explain the key distinctions between them.
What Is a Corporation?
Businesses can be operated in a number of different forms, including as a corporation, as a proprietorship, or as a partnership. Most businesses of any significant size operate as corporations and, as such, this text will focus on the accounting information related to that form of business. However, most of the accounting issues that we will identify in the text also apply in some degree to the other forms of business. If you have a good understanding of corporate accounting, it is not a big challenge to understand the nuances of accounting for proprietorships or partnerships.
As previously mentioned, corporations are owned by shareholders, with the initial shareholders having provided cash or other assets to a corporation in exchange for share certificates. These shares are called common shares. One of the key distinctions between corporations and other forms of business is that corporations are separate legal entities; that is, they are legally distinct from their owners. This is where the “Limited” or “Ltd.” that you see in the names of many corporations comes from; it refers to the fact that the company has limited legal liability. Since the corporations are separate legal entities, they can enter into contracts and be sued. In the event the company fails, the liability of shareholders is limited to their investment in the corporation.
There are two main types of corporations: public companies (which are also known as publicly traded companies) and private companies (which are also known as privately held companies). The distinction between the two is that the shares of public companies trade on public stock exchanges such as the Toronto Stock Exchange (TSX), while the shares of private companies trade privately and are not available through public exchanges. The shares of public companies are often widely held, meaning that they are owned by a large number of individuals or entities. Some portion of their ownership will usually change hands every day. On the other hand, shares of a private company are often narrowly held, meaning that they are owned by a relatively small number of people. It is not as easy to transfer ownership in a private company.
Shareholders are not typically involved in the day-to-day operations, except in small private corporations. Given that public companies have a large number of shareholders who are not involved in day-to-day activities, the shareholders typically elect a board of directors to represent them. The board of directors has the authority to hire (and fire if necessary) the management team who will manage the company’s day-to-day operations. These senior executives, along with the other managers they hire, are known as management. To keep shareholders informed of the performance of their investment in the company, management reports periodically to the shareholders. Financial statements are normally prepared for shareholders quarterly (every three months). Annual financial statements are also produced and are included in the company’s annual report. It is these annual financial statements that we will be focusing on.
For Example
There are more than 2.5 million businesses operating as corporations in Canada. The vast majority of these are small, privately held companies. In fact, there were only 3,155 public companies trading on Canada’s two largest stock exchanges, the TSX and TSX Venture Exchange, as of June 30, 2017. While the number of public companies may be small, their value is very significant. These 3,155 public companies were valued at $2,857.9 billion, according to the quoted market value of their shares.
What Diferentiates a Corporation from Other Forms of Business?
There are a number of key distinctions between corporations and the other forms of business: partnerships and proprietorships. Exhibit 1.4 outlines a number of the key distinctions to help you understand them. It is important to be aware of these differences, but also to understand that there are circumstances in which it makes sense to organize a business using each one of these three main forms of business.
1.4 Key Distinctions between the Forms of Business Distinguishing FeatureCorporation
Number of ownersCan be a single owner or multiple owners
Separate legal entity?Yes, personal assets of shareholders are not at risk in the event of legal action against company
Single owner
No, personal assets of owner are at risk in the event of legal action
Owner(s) responsible for debts of the business? Only to extent of investmentYes
Taxed? Yes, taxed separately
No, profits taxed in hands of owner
Costs to establish Most expensive Least expensive
Cost to maintain Most expensive Least expensive
Activities of a Business
LEARNING OBJECTIVE 4
Multiple owners
No, partners’ personal assets are at risk in the event of legal action
Yes
No, profits taxed in hands of owners
Moderately expensive
Moderately expensive
EXHIBIT 1.5
The Three Categories of Business Activities
Video
Explain the three categories of business activities and identify examples of transactions related to each category.
What Are the Three Categories of Business Activities?
To understand the information in financial statements, it is useful to think about the fundamental types of activities that all businesses engage in and report on. As illustrated in Exhibit 1.5, all
EXHIBIT
Take5
of the activities of businesses can be grouped into three categories: (1) financing activities, (2) investing activities, and (3) operating activities. Each of these involves inflows and outflows of cash into and out of the company.
Now, let’s explore each category.
What Are Examples of Financing Activities?
The first activities of all companies involve obtaining the funding (or financing) needed to purchase the equipment or buildings they need to start operations. At the outset of the business, funding may also be required to pay for the initial purchase of inventory, pay a landlord a deposit on rented space, pay for advertising, and so on. While these activities are a necessity for new companies, they also continue as companies grow and expand. Companies obtain funding from two primary sources: (1) investors and (2) creditors, as explained in the Key Points Companies obtain funding from investors by issuing them shares (common shares) in the company in exchange for cash or other assets. These shares represent the investor’s ownership interest in the company. For example, if the investor owns 10% of the shares issued by the company, they normally own 10% of the company. Since investors own, or hold, shares in the company, we normally refer to them as shareholders. Shareholders purchase shares seeking to generate a return, which may be realized in two different ways. First, they hope to receive dividends. These are payments made by a company that distribute a portion of the company’s profits to shareholders. The other way shareholders seek to make a return is by being able to sell their shares to other investors for more than they paid for the shares. This gain or increase in value is known as capital appreciation. Of course, when the sale occurs, investors may also experience a loss if they receive less than the initial amount paid for the shares. The funds that flow into the company from issuing shares to its shareholders form part of what is called shareholders’ equity
For Example
Companies often try to establish a pattern of declaring and paying dividends in order to make their shares attractive to investors. The Bank of Montreal holds the record among Canadian public companies for the longest continuous stretch of paying dividends to its shareholders, having done so each year since 1829!
Once a company has some shareholders’ equity, it is then able to seek funding from the second primary financing source, creditors. Creditors are entities that lend money to a company. Banks are the most common example of a creditor. Creditors seek a return from the money they lend to a company. This return is the interest they receive for the time they have allowed the company to use their money. Of course, creditors also expect to get their money back. This is known as a return of principal
If a company is operating profitably, it has an internal source of new funding because generally not all of those profits are being paid out to shareholders as dividends. Any profits that are kept or retained by the company are known as retained earnings. If a company’s retained earnings are less than the funding it requires to grow (such as money to purchase additional equipment or carry new lines of inventory), the only way it can expand is to obtain more funds from investors (existing shareholders or new investors) or to borrow from creditors. How much to borrow from creditors and how much funding to obtain from investors are important decisions that the company’s management must make. Those decisions can determine whether a company grows, goes bankrupt, or is bought by another company. Exhibit 1.6 shows examples of financing activities.
Typical Financing Activities
Inflows: Borrowing money
Issuing shares
Outflows: Repaying loan principal Paying dividends
KEY POINTS
A company’s financing comes from two sources:
• investors, through the issuance of shares
• creditors, through taking out loans or making purchases on credit
Typical Financing Activities
EXHIBIT 1.6
Another random document with no related content on Scribd:
terrible Midgard snake were they to venture any farther—Thor persistently rowed on, until he fancied they were directly above this monster.
“On the dark bottom of the great salt lake, Imprisoned lay the giant snake, With naught his sullen sleep to break.”
T ’ F , O (Pigott’s tr.).
Baiting his powerful hook with the ox head, Thor angled for Iörmungandr, while the giant drew up two whales, which seemed enough for an early morning’s meal.
As Hymir was about to propose a return, Thor suddenly felt a jerk, and began pulling as hard as he could, for he knew by the resistance of his prey, and the terrible storm lashed up by its writhings, that he had hooked the Midgard snake. In his determined efforts to force him to rise to the surface, Thor braced his feet so strongly against the bottom of the boat that he went through it and stood on the bed of the sea.
After an indescribable struggle, the monster’s terrible venombreathing head appeared, and Thor, seizing his hammer, was about to annihilate it when the giant, frightened by the proximity of Iörmungandr, and fearing lest the boat should sink and he become its prey, drew his knife, cut the fishing line, and thus allowed the monster to drop back like a stone to the bottom of the sea.
“The knife prevails: far down beneath the main The serpent, spent with toil and pain, To the bottom sank again.”
T ’ F , O (Pigott’s tr.).
Angry with Hymir for his inopportune interference, Thor dealt him a blow with his hammer which knocked him overboard; but Hymir, undismayed, waded ashore, and met him as he returned to the beach. Hymir then took both whales, his share of the fishing, upon his
back, to carry them to the house; and Thor, wishing to show his strength also, shouldered boat, oars, and fishing tackle, and followed him.
Breakfast being disposed of, Hymir challenged Thor to show his strength by breaking his goblet; but although the thunder-god threw it with irresistible force against stone pillars and walls, it remained whole and was not even bent. In obedience to a whisper from Tyr’s mother, however, Thor suddenly hurled it against the giant’s forehead, the only substance tougher than itself, where it was shivered to pieces. Hymir, having thus seen what Thor could do, told him he might have the required kettle, which Tyr vainly tried to lift, and which Thor could raise from the floor only after he had drawn his belt of strength up to the very last hole.
“Tyr twice assayed
To move the vessel, Yet at each time
Stood the kettle fast. Then Môdi’s father By the brim grasped it, And trod through The dwelling’s floor.”
L H (Thorpe’s tr.).
The wrench with which he pulled it up, however, greatly shattered the giant’s house and broke his floor to pieces. As Tyr and Thor were departing, the latter having clapped the huge pot on his head in the guise of a hat, Hymir summoned the other frost giants, and proposed that they should slay their inveterate foe. Before they could overtake him, Thor, turning around, became aware of their pursuit, and, hurling Miölnir repeatedly at them, slew them all ere he carried the kettle in triumph to Ægir to enable him to brew enough ale for the harvest feast.
The physical explanation of this myth is, of course, a thunder storm (Thor), in conflict with the raging sea (the Midgard snake), and
the breaking up of the polar ice (Hymir’s goblet and floor) in the heat of summer.
The gods now joyfully accepted Ægir’s invitation to be present at his feast, went there in festive array, and were ever after wont to celebrate the harvest home in his coral caves.
“Then Vans and Æsir, mighty gods, Of earth and air, and Asgard, lords,— Advancing with each goddess fair, A brilliant retinue most rare,— Attending mighty Odin, swept Up wave-worn aisle in radiant march.”
V (J. C. Jones).
Ægir, as we have seen, ruled over all the sea with the help of the treacherous Ran. Both of these divinities were considered cruel by the Northern nations, who had much to suffer from the sea, which, surrounding them on all sides, ran far into the heart of their countries by means of the numerous fiords, and often swallowed the ships of their vikings, with all the men on board.
“We Goth-folk know indeed That the sea is a foe full deadly, and a friend that fails at need, And that Ran, who dwells thereunder, will many a man beguile.”
S V (William Morris)
Besides these principal divinities of the sea, the Northern nations believed in mermen and mermaids, the latter having swan plumage or seal garments, which they sometimes laid for a moment upon the beach, and if a mortal secured them he could compel the fair maidens to remain ashore.
Other divinities of the sea.
“She came through the waves when the fair moon shone
(Drift o’ the wave and foam o’ the sea); She came where I walked on the sands alone, With a heart as light as a heart may be.”
L. E. R.
There were also malignant marine monsters who were known as Nicors, from whose name has been derived the proverbial Old Nick. Many of the lesser water divinities had fish tails; the females bore the name of Undines, and the males of Stromkarls, Nixies, Necks, or Neckar. These water spirits often left their native streams, especially during the middle ages, to appear at village dances, where they were recognized by the wet hem of their garments. They often sat beside the flowing brook or river, playing on a harp, or sang alluring songs while combing out their long golden or green hair
“The Neck here his harp in the glass castle plays, And mermaidens comb out their green hair always, And bleach here their shining white clothes.”
S (Keightley’s tr.).
The Nixies, Undines, and Stromkarls were particularly gentle and lovable beings, and were very anxious indeed to obtain repeated assurances of their ultimate salvation.
Many stories are therefore told of priests or children meeting these spirits playing by a stream, and taunting them with future damnation, which threat turned the joyful music to pitiful wails. But when priest or children, discovering their mistake, hastened back to the stream and assured the green-toothed water sprites of future redemption, they invariably resumed their happy strain.
“Know you the Nixies, gay and fair? Their eyes are black, and green their hair— They lurk in sedgy shores.”
M .
River nymphs.
Besides Elf or Elb, the water sprite who gave its name to the Elbe River in Germany, the Neck, from whom the Neckar derives its name, and old Father Rhine, with his numerous daughters (tributary streams), the most famous of all the lesser water divinities is the Lorelei, the siren maiden who sits upon the Lorelei rock near St. Goar, on the Rhine, and whose alluring song has enticed many a mariner to death. The legends concerning this siren are very numerous indeed, one of the most ancient being as follows:
Lorelei was an immortal, a water nymph, daughter of old Father Rhine; during the day she dwelt in the cool depths of the river bed, but late at night she appeared in the moonlight, sitting aloft upon a pinnacle of rock, in full view of all who passed up or down the stream. At times, the evening breeze wafted some of the notes of her song to the boatmen’s ears, when, forgetting time and place in listening to these enchanting melodies, they drifted upon the sharp and jagged rocks, where they invariably perished.
“Above the maiden sitteth, A wondrous form, and fair; With jewels bright she plaiteth Her shining golden hair: With comb of gold prepares it, The task with song beguiled; A fitful burden bears it— That melody so wild.
“The boatman on the river Lists to the song, spell-bound; Oh! what shall him deliver From danger threat’ning round? The waters deep have caught them, Both boat and boatman brave; ’Tis Loreley’s song hath brought them Beneath the foaming wave.”
S , H (Selcher’s tr.).
The Lorelei and the fisherman.
One person only is reported to have seen the Lorelei close by, a young fisherman from Oberwesel, who met her every evening by riverside, and spent a few delightful hours with her, drinking in her beauty and listening to her entrancing song. Tradition further relates that ere they parted the Lorelei invariably pointed out the places where the youth must cast his nets on the morrow—instructions which he always obeyed, and which invariably brought him success.
One night the young fisherman was seen going towards the river, but as he never returned search was made for him. No clew to his whereabouts being found, the credulous Germans finally reported that the Lorelei had dragged him down to her coral caves that she might enjoy his companionship forever.
LORELEI AND THE FISHERMAN.—Paul Thumann.
According to another version, the Lorelei, perching on the rocks above, and luring the fishermen by her songs, caused so many deaths that an armed force was once sent out at nightfall to surround and seize her. But the water nymph used her magic to lay such a powerful spell upon the captain and his men that they could move neither hand nor foot. While they stood motionless around her, the Lorelei divested herself of all her ornaments, which she flung into the waves below; then, chanting a spell, she lured the waters up to the top of the rock, and the soldiers saw her spring into a sea-green chariot drawn by white-maned steeds, and drive rapidly away. A few moments later the Rhine had subsided to its usual level, the spell was broken, and the men recovered the power of motion, and retreated to announce how their efforts had been baffled. Since then, however, the Lorelei has never been seen, and the peasants declare that she still resents the insult offered her and will no longer leave her coral caves.
CHAPTER XXI. BALDER.
O and Frigga, we are told, were parents of twin sons as dissimilar in character and physical appearance as it was possible to be; for while Hodur, god of darkness, was somber, taciturn, and blind, like the obscurity of sin, which he was supposed to symbolize, Balder, the beautiful, was the pure and radiant god of innocence and light. The snowy brow and golden locks of this Asa seemed to send out beams of sunshine to gladden the hearts of gods and men, by whom he was equally beloved.
“Of all the twelve round Odin’s throne, Balder, the Beautiful, alone, The Sun-god, good, and pure, and bright, Was loved by all, as all love light.”
V (J. C. Jones).
Balder, attaining his full growth with marvelous rapidity, was admitted to the council of the gods, and married Nanna (blossom), the daughter of Nip (bud), a beautiful and charming young goddess, with whom he lived in perfect unity and peace. He took up his abode in the palace of Breidablik, whose silver roof rested upon golden pillars, and whose purity was such that nothing common or unclean was ever allowed within its precincts.
Nanna.
The god of light was well versed in the science of runes which were carved on his tongue; he knew the various virtues of the simples, one of which, the camomile, was always called “Balder’s
brow,” because its flower was just as immaculately pure as his forehead. The only thing hidden from Balder’s radiant eyes, at first, was the perception of his own ultimate fate.
“His own house Breidablik, on whose columns Balder graved The enchantments that recall the dead to life. For wise he was, and many curious arts, Postures of runes, and healing herbs he knew; Unhappy! but that art he did not know, To keep his own life safe, and see the sun.”
B D (Matthew Arnold).
As Balder the beautiful was always smiling and happy, the gods were greatly troubled when they finally saw the light die out of his blue eyes, a careworn look come into his face, and his step grow heavy and slow. Odin and Frigga, seeing their beloved son’s evident depression, tenderly implored him to reveal the cause of his silent grief. Balder, yielding at last to their anxious entreaties, confessed that his slumbers, instead of being peaceful and restful as of yore, had been strangely troubled of late by dark and oppressive dreams, which, although he could not clearly remember them when he awoke, constantly haunted him with a vague feeling of fear.
“To that god his slumber Was most afflicting; His auspicious dreams Seemed departed.”
L V (Thorpe’s tr.).
When Odin and Frigga heard this, they were troubled indeed, but declared they were quite sure nothing would harm their son, who was so universally beloved. Yet, when the anxious father and mother had returned home, they talked the matter over, acknowledged that they also were oppressed by strange forebodings, and having
learned from the giants that Balder really was in danger, they proceeded to take measures to avert it.
Frigga, therefore, sent out her servants in every direction, bidding them make all living creatures, all plants, metals, stones—in fact, every animate and inanimate thing—register a solemn vow not to do any harm to Balder. All creation readily took the oath, for all things loved the radiant god, and basked in the light of his smile. So the servants soon returned to Frigga, telling her that all had been duly sworn except the mistletoe, growing upon the oak stem at the gate of Valhalla, which, they added, was such a puny, inoffensive thing that no harm could be feared from it.
“On a course they resolved: That they would send To every being, Assurance to solicit, Balder not to harm. All species swore Oaths to spare him; Frigg received all Their vows and compacts.”
S ’ E (Thorpe’s tr.).
Frigga now resumed her spinning with her usual content, for she knew no harm could come to the child she loved best of all. Odin, in the mean while, also sorely troubled, and wishing to ascertain whether there was any cause for his unwonted depression, resolved to consult one of the dead Valas or prophetesses. He therefore mounted his eight-footed steed Sleipnir, rode over the tremulous bridges Bifröst and Giallar, came to the entrance of Nifl-heim, and, passing the Hel-gate and the dog Garm, penetrated into Hel’s dark abode.
The Vala’s prophecy.
“Uprose the king of men with speed, And saddled straight his coal-black steed;
Down the yawning steep he rode, That leads to Hela’s drear abode.”
D O (Gray).
To his surprise, he noticed that a feast was being spread in this dark realm, and that the couches had all been covered with tapestry and rings of gold, as if some highly honored guest were expected before long. Hastening on, Odin finally reached the grave where the Vala had rested undisturbed for many a year, and solemnly began to chant the magic spell and trace the runes which had the power of raising the dead.
“Thrice pronounc’d, in accents dread, The thrilling verse that wakes the dead: Till from out the hollow ground Slowly breath’d a sullen sound.”
D O (Gray).
Suddenly the grave opened, and the prophetess slowly rose, inquiring who he was and why he thus came to trouble her long rest. Odin, not wishing her to know that he was king of the gods, replied that he was Vegtam, Valtam’s son, and that he had awakened her to inquire for whom Hel was spreading her couches and preparing a festive meal. In hollow tones, the prophetess now confirmed all his fears by telling him that the expected guest was Balder, who would shortly be slain by Hodur, his brother, the blind god of darkness.
“Hodur will hither His glorious brother send; He of Balder will The slayer be, And Odin’s son Of life bereave. By compulsion I have spoken; Now I will be silent.”
S ’ E (Thorpe’s tr.).
But in spite of these sad tidings, and of the Vala’s evident reluctance to answer any other questions, Odin was not yet satisfied, and forced her to tell him who would avenge the murdered man by calling his assassin to account—a spirit of revenge and retaliation being considered a sacred duty among the races of the North.
Then the prophetess told him, as Rossthiof had predicted before, that Rinda, the earth-goddess, would bear a son to Odin, and that this divine emissary, Vali, would neither wash his face nor comb his hair until he had avenged Balder and slain Hodur.
“In the caverns of the west, By Odin’s fierce embrace comprest, A wondrous boy shall Rinda bear, Who ne’er shall comb his raven hair, Nor wash his visage in the stream, Nor see the sun’s departing beam, Till he on Hoder’s corse shall smile Flaming on the fun’ral pile.”
D O (Gray).
Having discovered this from the reluctant Vala, Odin, who, thanks to his visit to the Urdar fountain, already knew much of the future, now incautiously revealed some of his knowledge by inquiring who would refuse to weep at Balder’s death. When the prophetess heard this question, she immediately knew that it was Odin who had called her out of her grave, and, refusing to speak another word, she sank back into the silence of the tomb, declaring that none would ever be able to lure her out again until the end of the world had come.
“Hie thee hence, and boast at home, That never shall inquirer come To break my iron sleep again,
Till Lok has burst his tenfold chain; Never, till substantial Night Has reassum’d her ancient right: Till wrapt in flames, in ruin hurl’d, Sinks the fabric of the world.”
D O (Gray)
Odin had questioned the greatest prophetess the world had ever known, and had learned Orlog’s (fate’s) decrees, which he knew could not be set aside. He therefore remounted his steed, and sadly wended his way back to Asgard, thinking of the time, no longer far distant, when his beloved son would no more be seen in the heavenly abodes, and when the light of his presence would have vanished forever.
On entering Glads-heim, however, Odin was somewhat cheered when he heard of the precautions taken by Frigga to insure their darling’s safety, and soon, feeling convinced that if nothing would slay Balder he would surely continue to gladden the world with his presence, he cast aside all care and ordered games and a festive meal.
The gods at play.
The gods resumed their wonted occupations, and were soon casting their golden disks on the green plain of Ida, which was called Idavold, the playground of the gods.
At last, wearying of this pastime, and knowing that no harm could come to their beloved Balder, they invented a new game and began to use him as a target, throwing all manner of weapons and missiles at him, certain that no matter how cleverly they tried, and how accurately they aimed, the objects, having sworn not to injure him, would either glance aside or fall short. This new amusement was so fascinating that soon all the gods were assembled around Balder, at whom they threw every available thing, greeting each new failure with prolonged shouts of laughter. These bursts of merriment soon excited the curiosity of Frigga, who sat spinning in Fensalir; and seeing an old woman pass by her dwelling, she bade her pause and tell what the gods were doing to provoke such great hilarity. The old woman, who was Loki in disguise,
immediately stopped at this appeal, and told Frigga that all the gods were throwing stones and blunt and sharp instruments at Balder, who stood smiling and unharmed in their midst, daring them to touch him.
The goddess smiled, and resumed her work, saying that it was quite natural that nothing should harm Balder, as all things loved the light, of which he was the emblem, and had solemnly sworn not to injure him. Loki, the personification of fire, was greatly disappointed upon hearing this, for he was jealous of Balder, the sun, who so entirely eclipsed him and was generally beloved, while he was feared and avoided as much as possible; but he cleverly concealed his chagrin, and inquired of Frigga whether she were quite sure that all objects had joined the league.
Frigga proudly answered that she had received the solemn oath of all things, except of a harmless little parasite, the mistletoe, which grew on the oak near Valhalla’s gate, and was too small and weak to be feared. Having obtained the desired information, Loki toddled off; but as soon as he was safely out of sight, he resumed his wonted form, hastened to Valhalla, found the oak and mistletoe indicated by Frigga, and by magic arts compelled the parasite to assume a growth and hardness hitherto unknown.
From the wooden stem thus produced he deftly fashioned a shaft ere he hastened back to Idavold, where the gods were still hurling missiles at Balder, Hodur alone leaning mournfully against a tree, and taking no part in the new game. Carelessly Loki approached him, inquired the cause of his melancholy, and twitted him with pride and indifference, since he would not condescend to take part in the new game. In answer to these remarks, Hodur pleaded his blindness; but when Loki put the mistletoe in his hand, led him into the midst of the circle, and indicated in what direction the novel target stood, Hodur threw his shaft boldly. Instead of the loud shout of laughter which he expected to hear, a shuddering cry of terror fell upon his ear, for Balder the beautiful had fallen to the ground, slain by the fatal blow.
Death of Balder.
“So on the floor lay Balder dead; and round Lay thickly strewn swords, axes, darts, and spears, Which all the Gods in sport had idly thrown At Balder, whom no weapon pierced or clove; But in his breast stood fixed the fatal bough Of mistletoe, which Lok, the Accuser, gave To Hoder, and unwitting Hoder threw— ’Gainst that alone had Balder’s life no charm.”
B D (Matthew Arnold).
BALDER
Anxiously the gods all crowded around him, but alas! life was quite extinct, and all their efforts to revive the fallen sun-god were vain. Inconsolable at their loss, they turned angrily upon Hodur, whom they would have slain had they not been restrained by the feeling that no willful deed of violence should ever desecrate their peace steads. At the loud sound of lamentation the goddesses came in hot haste, and when Frigga saw that her darling was dead, she passionately implored the gods to go to Nifl-heim and entreat Hel to release her victim, for the earth could not live happy without him.
As the road was rough and painful in the extreme, none of the gods at first volunteered to go; but when Frigga added that she and Odin would reward the messenger by loving him most of all the Æsir, Hermod signified his readiness to execute the commission. To help him on his way, Odin lent him Sleipnir, and bade him good speed, while he motioned to the other gods to carry the corpse to Breidablik, and directed them to go to the forest and cut down huge pines to make a worthy pyre for his son.
Hermod’s errand.
“But when the Gods were to the forest gone, Hermod led Sleipnir from Valhalla forth And saddled him; before that, Sleipnir brook’d No meaner hand than Odin’s on his mane, On his broad back no lesser rider bore; Yet docile now he stood at Hermod’s side, Arching his neck, and glad to be bestrode, Knowing the God they went to seek, how dear. But Hermod mounted him, and sadly fared In silence up the dark untravel’d road
Which branches from the north of Heaven, and went All day; and daylight waned, and night came on. And all that night he rode, and journey’d so, Nine days, nine nights, toward the northern ice,
Through valleys deep-engulph’d by roaring streams. And on the tenth morn he beheld the bridge Which spans with golden arches Giall’s stream, And on the bridge a damsel watching, arm’d, In the straight passage, at the further end, Where the road issues between walling rocks.”
B D (Matthew Arnold).
While Hermod was traveling along the cheerless road to Niflheim, the gods hewed and carried down to the shore a vast amount of fuel, which they placed upon the deck of Balder’s favorite vessel, Ringhorn, constructing an elaborate funeral pyre, which, according to custom, was decorated with tapestry hangings, garlands of flowers, vessels and weapons of all kinds, golden rings, and countless objects of value, ere the immaculate corpse was brought and laid upon it in full attire.
One by one, the gods now drew near to take a last farewell of their beloved companion, and as Nanna bent over him, her loving heart broke, and she fell lifeless by his side. Seeing this, the gods reverently laid her beside her husband, that she might accompany him even in death; and after they had slain his horse and hounds and twined the pyre with thorns, the emblems of sleep, Odin, the last of the gods, drew near.
In token of affection for the dead and of sorrow for his loss, all laid their most precious possessions upon his pyre, and Odin, bending down, now added to the offerings his magic ring Draupnir. The assembled gods then perceived that he was whispering in his dead son’s ear, but none were near enough to hear what word he said.
These preliminaries ended, the gods now prepared to launch the ship, but found it so heavily laden with fuel and treasures that their combined efforts could not make it stir an inch. The mountain giants, witnessing the sad scene from afar, and noticing their quandary, said that they knew of a giantess called Hyrrokin, who dwelt in Jötunheim, and was strong enough to launch the vessel without any other
The funeral pyre.
aid. The gods therefore bade one of the storm giants hasten off to summon Hyrrokin, who soon appeared, riding a gigantic wolf, which she guided by a bridle made of writhing live snakes. Riding down to the shore, the giantess dismounted and haughtily signified her readiness to give them the required aid, if in the mean while they would but hold her steed. Odin immediately dispatched four of his maddest Berserkers to fulfill this task; but, in spite of their phenomenal strength, they could not hold the monstrous wolf until the giantess had thrown and bound it fast.
Hyrrokin, seeing them now able to manage her refractory steed, marched down the beach, set her shoulder against the stern of Balder’s ship Ringhorn, and with one mighty shove sent it out into the water. Such was the weight of the burden she moved, however, and the rapidity with which it shot down into the sea, that all the earth shook as if from an earthquake, and the rollers on which it glided caught fire from the friction. The unexpected shock almost made the gods lose their balance, and so angered Thor that he raised his hammer and would have slain the giantess had he not been restrained by his fellow gods. Easily appeased, as usual—for Thor’s violence, although quick, was evanescent—he now stepped up on the vessel once more to consecrate the funeral pyre with his sacred hammer. But, as he was performing this ceremony, the dwarf Lit managed to get into his way so provokingly that Thor, still slightly angry, kicked him into the fire, which he had just kindled with a thorn, where the dwarf was burned to ashes with the corpses of the faithful pair
As the vessel drifted out to sea, the flames rose higher and higher, and when it neared the western horizon it seemed as if sea and sky were all on fire. Sadly the gods watched the glowing ship and its precious freight, until it suddenly plunged into the waves and disappeared; nor did they turn aside and go back to their own homes until the last spark of light had vanished, and all the world was enveloped in darkness, in token of mourning for Balder the good.
