1
1 1
Demand and Supply
Specic objectives
By the end of this topic, the learner should be able to:
(a) Explain the meaning of demand;
(b) Explainthefactorswhichinuencedemandforaproduct;
(c) Distinguish between derived demand and joint demand;
(d) Derive a demand curve from a demand schedule;
(e) Distinguish between movement along a demand curve and
a shift in the demand curve;
(f) Explain the meaning of supply;
(g) Explainthefactorsthatinuencesupplyofaproduct;
(h) Derive a supply curve from a supply schedule;
(i) Distinguish between movement along a supply curve and
shift in a supply curve;
(j) Determine equilibrium price and equilibrium quantity;
(k) Discuss the effects of excess demand and excess supply
in the market;
(l) Explain the effect of a shift in demand curve on equilibrium
price and equilibrium quantity;
(m) Explain the effects of a shift in supply curve on equilibrium
price and equilibrium quantity;
(n) Explain other methods of determining the price of a
product.
2
Demand
Meaning of demand
Demand is the willingness and ability of an individual to buy a given commodity or service
at a given price at a given period of time. For demand to exist, an individual must have
both willingness and ability to purchase the commodity. For example, a given commodity
is selling at ksh50, for demand for this commodity to exist one must be willing to buy this
commodity and be able to raise the required amount for it payment that is ksh50.
Factors that inuence demand of a product in the market
Demandforaproductinthemarketisinuencedbythefollowingfactors:
(i) The price of the commodity
Price of the commodity. High price of the commodity hinders the buyers’ ability to
purchase a given product while low price of a product increases the buyers’ ability to buy
that product due to its affordability.
(ii) Consumer’s level of income
Consumers level of income. Income is the amount of money one earns from employment.
The more the income of an individual, the higher the ability to buy goods or services and
the lower the income, the lower the ability of an individual to buy the same product.
(iii) The size of population
The size of production. Population refers to the number of people living in a given area
at a particular period of time. An increase in the number of people in an area is likely to
increase the quantity of goods and services demanded, while a decrease in that population
is likely to lead to a decrease in the quantity demanded of the same goods and services.
(iv) Tastes and preference
This refers to like and dislike of an individual towards a particular good or service. A
positive change in taste and preferences towards a particular product will lead to an
increase in the demand for the product, while a negative change will lead to decreased
demand of the same product.
(v) Changes in weather conditions
Certain goods are meant for use during certain weather conditions. For example, umbrellas
are mainly used during the rainy season. Therefore, the demand for umbrellas is higher
during rainy weather conditions than during dry weather conditions.
(vi) Advertising
Advertising is the act of informing and persuading people to buy a product. Persistent
advertising of a product is likely to bring about increased demand for the commodity.
New products in the market that are advertised tend to sell more than those that are not
advertised.
3
Fig 1.1: Advertisement informs and persuades people to buy a commodity.
(vii) Price of related commodities
Goods can be related in two ways:
(a) Substitute goods-these are goods that can be used instead or in place of others.
For example, Omo and Toss are both detergents for washing clothes, if the price of
Omo decrease lower than the price of Toss, then the demand for Omo is likely to be
higher than that of Toss. Likewise if the price of Toss decreases lower than the price of
Omo, the demand for Toss is likely to be higher than that of Omo.
(b) Compliments. Compliments are goods which are used together. They are also
called complimentary goods. For example, a car and petrol. An increase in demand for
cars will lead to an increase in demand for petrol while a decrease in demand for cars
will lead to a decrease in demand for petrol.
Fig. 1.2: Vehicles being fuelled at a petrol station; vehicles and petrol are complimentary goods.
(ix) Anticipated change in prices
Anticipated change in price of a commodity is the price at which a commodity is likely
to be sold in future. For example, if the price of sugar is anticipated to fall in the future
then the current demand for sugar will decrease and if the price of sugar is anticipated
to rise in the future the current demand for sugar will rise.
4
(ix) Availability of credit
The ability of consumers to buy products is limited by their nancial abilities. This
ability can be increased by the seller oering goods on credit or by the buyer geing
loans to acquire the products. This will lead to an increase in demand for the products.
(x) Government policy
These are government regulations and decisions that are made and aect the demand
for commodities. For example, if the government increases the tax on a given product,
its price will increase leading to a decrease in the demand for the product, likewise
if the government lowers tax on a given products, its price will reduce leading to an
increase in demand for the product.
Fig. 1.3: Parliament building where government policies are formulated.
Derived demand and joint demand
Derived demand of a commodity arises from the demand of another commodity which
facilitates production of the latter commodity.
Joint demand refers to the demand for a commodity which arises from the demand
for another commodity which are used together. For example, there is a joint demand
between baeries and a torch. The demand for baeries arise from the demand for a
torch.
Demand schedule
Demand schedule is a tabular represention of the quantity of a commodity demanded at
various prices at a given period of time. There are two types of demand schedules namely:
(i) Individual demand schedule
(ii) Market demand schedule
(i) Individual demand schedule
This is a tabular representation of the quantity demanded by an individual at different
prices at a given period of time.
Table 1.1 on page 6 illustrates individual demand schedule for potatoes demanded by Mr.
5
Bundu at Wakulima Market in Nairobi. The table shows that when the price is Ksh 8, Mr.
Bundu is willing to buy only 1 kg of potatoes. At Ksh 7, Mr. Bundu is willing to buy 3kg.
Similarly, at Ksh 6, he is willing to buy 5kg. Mr. Bundu’s willingness to buy increases as
the price of the potatoes goes down. This implies that the higher the price, the lower the
quantity demanded.
Price
(Ksh)
Quantity of potatoes
demanded (kg)
8 1
7 3
6 5
5 7
4 9
3 11
2 13
1 15
Table 1.1: Individual demand schedule for Mr. Bundu.
(ii) Market demand schedule
A market demand schedule is a tabular representation of the quantity demanded by
different people in the market at different prices at a given period of time. For example,
if in the market the only buyers were Mr. Bundu and Mr. Ayao, then the market demand
schedule can be as shown in Table 1.2 below. The market demand schedule shown
illustrates that the higher the price, the lower the quantity demanded in the market. For
example, at a price of Ksh 8, the quantity demanded in the market is 5kg of potatoes while
at a lower price of ksh 3, the quantity of potatoes demanded is 35kg.
The quantity demanded in the market at any given price is the total sum of the
individual quantities demanded of the commodity. For example, at a price of Ksh
7, the market demand quantity of 11 kg is the total of Mr. Bundu’s 3kgs and Mr.
Ayao’s 8kg.
Price
(Ksh)
Quantity of potatoes demanded (kg)
Market
demand (kg)
Mr. Bundu Mr. Ayao
8 1
4 5
7 3
8 11
6 5
12 17
5 7
16 23
4 9
20 29
3 11
24 35
2 13
28 41
1 15
32 47
Table 1.2: Market demand schedule for Mr. Bundu and Mr. Ayao.
6
Demand curve
A demand curve is a graphical representation of the relationship between the quantity of
a commodity demanded and the corresponding prices at a given period of time.
There are two types of demand curves. These are;
(i) individual demand curve.
(ii) market demand curve.
(i) Individual demand curve
This is derived from the individual demand schedule. We can use Mr. Bundus demand
schedule to derive a demand curve as illustrated below in Table 1.1.
0 10 20 30 40 50
1
2
3
4
5
6
7
8
Price (P) (Ksh)
Quantity demanded (Q) (kg)
D
D
Fig 1.4 Individual demand curve for Mr. Bundu
The quantity demanded is plotted on the x-axis (horizontal axis) while the price is plotted
on the y-axis (vertical axis). The demand curve slopes from left to right downwards and
is labelled DD. This slope illustrates that at high prices, the quantity demanded of the
commodity is less while at low prices, the quantity demanded of the commodity is high.
For example, at a price of Ksh. 6, the quantity of potatoes demanded is 5kgs while at the
price of Ksh. 2, the quantity for potatoes demanded increases to 13kgs.
(ii) Market demand curve
The market demand curve is derived from the market demand schedule. From the market
demand schedule in Table 1.2, we can derive a market demand curve as shown in Fig 1.5
on page 8.
7
0 10 20 30 40 50
1
2
3
4
5
6
7
8
Price (P) (Ksh)
D
D
Quantity demanded (Q) (kg)
Fig. 1.5: Market demand curve
The curve depicted above illustrates that at higher prices, the quantity demanded is low
while at lower prices the quantity demanded is high. Thus, at a price of ksh 7, the quantity
demanded is 11kg while at the price of ksh 3, the quantity demanded is 35kg.
The law of demand
The law of demand illustrates graphical relationship between quantities of a commodity
demandedagainsttheircorrespondingpricesasillustratedingure1.4and1.5above.
The law of demand states that the higher the price of a commodity, the lower the
quantity demanded and the lower the price, the higher the quantity of a commodity
demanded at a given period of time when other factors are held constant.
This means that the law of demand only applies when all the other factors that
determine demand of a commodity remain unchanged. These factors include the
following:
(i) There should be no change in the income of the consumers: If consumers’ income change,
then their ability to buy commodities may not change, even if prices change.
(ii) The taste and preference of the individual consumers should not change: A consumer will
not change his/her demand for a commodity if he or she has developed a special
liking for it even if its price changes.
(iii) No future expected changes in the price of the commodity: When consumers expect a
future change in price, they may not respond effectively to the law of demand. For
example, they may buy more even if the price is high if they anticipate a an increase
in the future price of commodities.
8
(iv) There should be no changes in the price of related commodities: If there is a change
in the price of a substitute commodity, this would affect the quantity demanded of
other substitutes. Also if there is a change in the price of a complimentary good, it
is bound to affect the quantity demanded of other complimentary goods.
(v) The product should not be addictive or habitual: This implies that if a product is addictive
or habitual an increase in price may not necessarily cause a reduction in the quantity
demanded of the commodity. This violates the law of demand.
Movement along a demand curve and shift in a
demand curve
(i) Movement along a demand curve
This is the response of a quantity demanded of a commodity to price changes. It also refers
to a change in quantity demanded at different price levels. If the price of a commodity
changes, there will be an automatic change in the quantity demanded at a given period of
time.Themovementalongademandcurveisillustratedinthegurebelow.
Quantity demanded (Q) (kg)
Price (P) (Ksh)
P
1
P
P
2
Q
2
Q
Q
1
C
D
D
A
B
Mov ement
along a
demand
curve
O
Fig 1.6: Movement along a demand curve.
The diagram in Fig. 1.6 above illustrates that at price OP, the quantity demanded is OQ.
If the price decreases from OP to OP
1,
the quantity demanded increases from OQ to OQ
1,
hence the downward movement along the demand curve as illustrated by AB. If the price
increases from OP to OP
2
, the quantity demanded decreases from OQ to OQ
2
; hence the
upward movement along the demand curve as illustrated by AC.
9
(ii) Shift in a demand curve
This is the change in demand of a commodity which is caused by other factors other than
demand. This curve explores why diffrent quantities will be demanded at the same price
levels..
Quantity demanded (Q) (kg)
Price (P) (Ksh)
P
Q
1
Q
2
Q
D
2
O
D
D
1
D
2
D
D
1
Fig 1.7: Shift in a demand curve.
A shift from DD to D
1
D
1
, to the right means an increase in demand and this may be caused
by one or all of the following factors:
(i) An increase in consumers’ income.
(ii) A positive change in consumers taste and preference.
(iii) An increase in price of substitute commodities
(iv) A decrease in price of complimentary commodities.
(v) An aggressive product promotion campaign.
(vi) An increase in the size of population.
(vii) A favourable government policy for example, reduced tax.
A shift of the demand curve from DD to D
2
D
2
to the left shows a decrease in demand and
may be caused by one or all of the following factors;
(i) A decrease in price of substitute commodities.
(ii) A decrease in consumers income.
(iii) A negative change in individual consumer’s taste and preference.
(iv) An increase in the price of a complimentary product.
(v) A less aggressive product promotion campaign.
(vi) A decrease in the size of population.
(vii) An unfavourable government policy for example, an increase in tax.
10
Exercises 1.1
1. (a) i) Dene the term demand.
ii) Name the two conditions that must be present for demand to exist.
iii) State four factors which inuence the demand of a product.
(b) Dene each of the following concepts.
i) Complementary goods
ii) Substitute goods
iii) Movement along a demand curve
iv) The individual demand curve and the market demand curve.
2. Distinguish between movement along a demand curve and shift in a demand curve.
3. Use the table below to draw a demand curve.
Price
(Ksh)
Quantity
demanded (kg)
8
6
7
12
6
18
5
24
4
30
3
36
2
42
1
48
4.  Apartfromchangeinprice,listotherfactorsthatinuencedemandforaproduct.
5.  Deneamarketdemandcurve.
6. State the law of demand.
7. Give one reason why a demand curve slopes downwards.
Meaning of Supply
Supply is the quantity of commodities that sellers are willing and able to bring to the market
for sale at the prevailing price over a given period of time. Supply do not necessarily refer
to the entire stock produced for sale but only the amount that is offered for sale in the
market at the prevailing price at a given period of time. For example, William has 100,000
bags of maize. If the price per bag of maize is ksh 1000 in the market, he may decide
to sell the entire stock or sell some 400 bags only. If he sells the 400 bags then that is his
supply to the market.
An individual supply is the quantity of a commodity that a seller is willing and
able to bring to the market at a given price over a given period of time. A market
supply is the total quantity of a commodity that sellers are willing and able to bring to
the market at a given price over a given period of time.
11
Factors which inuence supply of a product
The following factors aects the supply of a product in the market:
(i) The price of the commodity
If the prevailing price of a commodity in the market is high, then the quantity of that
commodity supplied will be high. On the other hand, if the price is low, the supply of the
commodity will be low.
(ii) Level of technology
The state of  technology used to produce a commodity can inuence the quantity
produced and hence the amount supplied to the market. If a producer adopts or improves
techniques of production, for example if a farmer decides to use machines in the farm,
then the production will be higher. Use of traditional methods on the other hand lead to
low production.
Fig 1.8: A combine harvester harvesting wheat; use of machines increases the level of production.
(iii) The prevailing weather conditions
Production of some commodities such as agricultural products depend on natural factors
like weather. Favourable weather conditions will lead to high production, hence high supply
while unfavourable conditions of weather lead to low production and hence low supply.
Movement of some goods to the market also depends on the weather condition. For
example,abusinessmanwhosuppliestimberfromtheforesttoanurbancentremaynd
itdifculttotransportthecommodityduringtherainyseason.Thisreducesthesupplyof 
timber in the market.
(iv) Government policy
These are rules and regulations put in place by the government to control various activities.
Favourable government policy like reduced tax on farm inputs increases production, hence
supply of agricultural commodities while withdrawal or implementation of unfavourable
policies like withdrawal of a subsidy reduces production and therefore reduces the supply
of products.
12
(v) The availability of factors of production
Producers require inputs such as land, labour and capital to produce goods or offer
services. When these factors are not readily available, production will be low. Availability
of inputs on the other hand leads to high production. Low production leads to low supply
of products and high production leads to high supply of products in the market.
(vi) The cost of production
The cost of production will determine the quantity of a commodity produced and
it’s supply in the market. Low costs of production leads to high production while high
production costs leads to low production.
(vii) Time for adjustment
Producers need time in order to adjust to the prevailing market trends. In agriculture,
farmers need time to prepare land, plant crops, weed and later harvest. Manufacturers also
need time to adjust their factory plants in order to meet the market demand. Immediately
there is a price increase, the supply may not be increased easily but after some time,
production will be higher leading to an increase in supply.
(viii) Future expectations
When sellers anticipate future changes in price of a commodity they may increase or
decrease the quantity supplied. For example, when they expect a future increase in price,
the supply will be low but when they expect a decrease in price, they will sell more.
(ix) Ease of entry into the industry
Insomesituations,itisnoteasyfornewrmstojoinintheproductionofacommodity.
Insuchacase,supplymaynotchangesignicantlybutif itiseasyforrmstojoinin
production of a commodity, supply will be high.
Supply schedule and supply curve
Supply schedule
Tabular representation of quantity of a commodity that a supplier is willing and able to
supply to the market at a given price over a given period of time. There are two types of
supply schedules namely:
(i) Individual supply schedule
(ii) Market supply schedule
(i) Individual supply schedule
This is a tabular representation of the total quantity of a commodity supplied to the
market by an individual at a given price over a given period of time.
13
Price
(Ksh)
Supply of oranges
per week (kg)
1 3
2 6
3 9
4 12
5 15
6 18
7 21
8 24
Table 1.5: A supply schedule.
Table 1.5 above illustrates a supply schedule for Mr. Mbijiwe who supplies oranges to
Kulecho market. It shows that the lower the price, the lower the quantity of the commodity
supplied and the higher the price, the higher the quantity supplied to the market.
(ii) Market supply schedule
A market supply schedule is a tabular representation of the total quantity of a commodity
supplied by all the sellers to the market at a given price over a given period of time.
Assuming that Mr. Mbijiwe and Mr. Matano are the only suppliers of oranges to Kulecho
market, the market supply schedule for the supply of oranges can be as illustrated in Table
1.6 below.
Price
(Ksh)
Quantity supplied Market
supply
(kg)
Mr.
Mbijiwe
Mr.
Matano
1 3 2 5
2 6 4 10
3 9 6 15
4 12 8 20
5 15 10 25
6 18 12 30
7 21 14 35
8 24 16 40
Table 1.6: A market supply schedule.
14
It shows that the quantity of oranges supplied to the market at a given price is the total
sum of the individual supply schedules in the market at the same price. At a prize of Ksh
3, the quantity of oranges supplied to the market is 15 kg. which is the sum total of Mr.
Mbijiwe’s and Mr. Matano’s individual supply of 9 kg and 6 kg. respectively.
It can also be observed that at higher prices, more quantity is supplied to the
market. For example, at Ksh 2 the quantity of oranges supplied to the market is 10
kg while at a higher price of Ksh 7, the quantity of oranges supplied to the market
increases to 35 kg.
Supply curve
A graphical representation of the relationship between the quantity of a commodity
supplied to the market and the corresponding price at a given period of time in form of a
graph. There are two types of supply curves namely:
(i) Individual supply curve
(ii) Market supply curve
(i) Individual supply curve
This is derived from individual supply schedule. This type of a supply curve shows the
relationship between the quantity supplied by an individual to the market at different
prices over a given period of time. For example, Mbijiwe’s individual supply curve can be
derived from Mbijiwe’s supply schedule as shown in Fig. 1.9 below.
Price (P) (Ksh)
Quantity supplied (Q) (kg)
S
S
Fig 1.9: Individual supply curve.
From the graph, it can be observed that the quantity supplied is plotted on the x-axis
(horizontal axis) while the price is plotted on the y-axis (vertical axis). The supply curve
slopes from left to right upwards and is labelled SS. This slope indicates that at a low price,
the quantity supplied is low while at a high price, the quantity supplied is high.
15
(ii) Market supply curve
This is derived from the market supply schedule. It shows the relationship between the
total quantity of a commodity brought to the market by all the sellers at different prices
over a given period of time.
Fig 1.10 below shows the market supply curve derived from the market supply
schedule table 1.6 on page 15.
Price (P) (Ksh)
Quantity supplied (Q) (kg)
S
S
Fig 1.10: Market supply curve.
The market supply curve derived shows that the supply curve slopes from the left to the
right upwards. This indicates that when the price is low, the quantity supplied is low and
when the price is high, the quantity supplied is also high.
The law of supply
The law of supply illustrates a graphical relationship between quamtities of a commodity
suppliedagainsttheircorrespondingpricesasillustratedingure1.10.
It states that, the higher the price of a commodity, the higher the quantity supplied
and the lower the price, the lower the quantity supplied to the market when all factors
are held constant.
This law is illustrated by a supply curve and it only upholds when other factors
that determine the supply of a commodity are held constant. These factors are known
as assumptions of law of supply.
Some of the assumptions that allow the law to apply include:
(i) Suppliers have perfect knowledge of the price changes in the market.
(ii) Suppliers have the ability to offer any quantity of a commodity to the market at any
price.
(iii) Consumers have rational consumption behaviour.
(iv) Therearenoabnormalpriceuctuationsinthemarket.
16
Movement along a supply curve and shift in a supply curve
(i) Movement along a supply curve
It is also called change in quantity of a commodity supplied and it refers to the response of
the quantity of a commodity supplied to price changes in the market. Thus the movement
along a supply curve is caused by change in price of the commodity in the market. The
change in price may be a decrease or an increase.
The movement is illustrated in Figure 1.11 below.At price OP, the quantity supplied
is OQ. When the price increases from OP to OP
1
, the quantity supplied increases from
OQ to OQ
1
. Hence the upward movement along the supply curve as indicated by
AB. When the price decreases from OP to OP
2
, the quantity supplied decreases from
OQ to OQ
2
. Hence the downward movement along the supply curve as illustrated by
AC. The movement AB and AC along the supply curve SS show changes in quantity
supplied as price level changes.
Quantity supplied(Q) (kg)
Price (P) (Ksh)
P
2
P
P
1
Q
1
Q
2
Q
C
A
B
O
S
S
Fig 1.11: Movement along a supply curve.
(ii) Shift in a supply curve
This is a change in the supply of a commodity which is caused by change in other factors
otherthanthepriceofthecommodityasillustratedingure1.11below.
A shift in a supply curve to the right from SS to S
1
S
1
indicates an increase in quantity
supplied and may be caused by the following factors:
a) Improved technology.
b) Favourable weather conditions.
c) Availability of factors of production.
d) Favourable government policy such as a reduction of tax on inputs.
e) A decrease in the cost of production.
f) Expected fall in price of the product in future.
17
Quantity supplied(Q) (kg)
Price (P) (Kshs)
P
Q
1
Q
2
Q
O
S
2
S
1
S
S
2
S
1
S
Fig 1.12: Shift in a supply curve.
A shift of the supply curve from SS to S
2
S
2
to the left shows a decrease in quantity supplied
and may be caused by factors such as:
a) Unfavourable weather conditions.
b) Use of traditional techniques in the production process.
c) Inadequate supply of factors of production.
d) High cost of production.
e) Expected increase in price of the product in future.
f) Unfavourable government policy such as removal of subsidies.
Equilibrium price and quantity
Equilibrium price is price at which sellers are willing to sell a stated quantity of a
commodity which consumers are willing and able to buy on the other hand.
Table 1.7 below shows combined demand and supply schedules for maize sold in a certain
market.
Price (kg) (Ksh) Quantity demanded (kg) Quantity supplied (kg)
20 500 100
30 450 250
40 300 300
50 250 350
60 200 400
70 150 600
Table 1.7: Combined demand and supply schedule.
18
Equilibrium quantity is the quantity of a commodity that sellers are willing to sell at
given price and consumers are willing and able to buy.
In a market, suppliers will only offer a certain quantity of a commodity to the market
at a given price. Also, consumers will only buy what they can afford at a given price.
When suppliers oer a certain quantity of a commodity which the consumers are
willing and able to buy at a given price, then the quantity supplied will be equal to the
quantity demanded.
The equilibrium price and quantity curve below has been derived from the combined
demand and supply schedule above.
80
70
60
50
40
30
20
10
0
100 200 300 400 500 600 700 800
*
*
*
*
*
*
*
*
*
*
*
Price per kilogram (P)
Quantity demanded and supplied
E
Fig 1.13: Determination of equilibrium quantity and equilibrium price.
Equilibrium price is Ksh 40 and it is the price at which quantity demanded is equal to the
quantity supplied. The equilibrium quantity is therefore 300 kg.
The point at which the demand curve meets the supply curve is referred to as equilibrium
point (E).
Excess demand and excess supply
Excess demand
This is a situation where the consumers are willing to buy more of a commodity at a given
price than the quantity the suppliers are able to offer in the market. For example, when
the quantity demanded is more than the quantity supplied at a given price over a given
period of time.
19
Excess supply
This is a situation where suppliers are willing and able to supply more quantities of a
commodity at a given price over a given period of time than the quantity consumers are
willing and able to buy. Excess demand and excess supply can be illustrated in Fig 1.14
below.
Price (P)
Q
e
Q
2
S
S
P
1
D
Quantity demanded and supplied (Q) (kg)
D
Q
1
E
P
e
P
2
O
Excess supply
Excess demand
Fig 1.14: Excess demand and excess supply.
Effects of excess demand in the market
(a) Market instability
When the quantity supplied is less than the quantity demanded, this results into market
disequilibrium, hence market instability.
(b) Rationing
Beforethepricegoesbacktotheequilibriumposition,thesellersmaybegintosellspecic
quantities to the consumers. This may lead to disatisfacation of the customers’ needs.
(c) Hoarding
This refers to keeping or hiding commodities with an aim of causing shortage and increase
the price in future. When there is excess in demand some sellers may decide to keep or
hidethecommoditytoincreaseprotinfuture.
(d) Queuing
Excess demand of a product in the market may force the buyer to queue at the points of
sale. This may result in high prices of a commodity.
20
Effects of excess supply in the market
(a) Market instability
When the quantity supplied is more than the quantity demanded, it results into market
disequilibrium.
(b) Surplus
When market has excess supply of a commodity, the prices of commodities may go down.
(c) High storage costs
The sellers may be forced to spend more on storage facilities in order to preserve goods
if they are perishable.
Exercise 1.2
1 Statevefactorsthatcaninuencesupplyofacommodity.
2. Make your own supply schedule and use it to draw a supply curve.
3. With the aid of a diagram, describe movement along a supply curve.
4. State the law of supply.
5. Deneeachofthefollowingterms:
(a) Equilibrium price.
(b) Equilibrium quantity.
6. Thetablebelowshowsacombineddemandandsupplyscheduleforshinacertain
market.
Price (P) (Ksh) Quantity demanded (kg) Quantity supplied (kg)
20 450 150
25 350 250
35 300 300
40 200 450
45 100 500
(i) Use the table above to illustrate equilibrium price and equilibrium quantity.
(ii) Indicate:
- Equilibrium price
- Equilibrium quantity
- Equilibrium point
Effects of shift in a demand curve and shift in a supply curve
21
on equilibrium price and equilibrium quantity
(a) Effects of shift in a demand curve on equilibrium price and equilibrium quantity
A shift of the demand curve is caused by a change in one or all of the factors that affect
demand other than the price of the commodity.
Assuming a normal demand curve DD, shift of a demand curve is illustrated using
g. 1.15 below. A shift of the demand curve to the right from DD to D
1
D
1
. will have the
following eects on the equilibrium price and quantity.
(i) Equilibrium point shifts upwards to right from E to E
1
,
(ii) The equilibrium price increases from P
e
to P
e1
.
(iii) Equilibrium quantity increases from Q
e
to Q
e2
.
A shift of the demand curve to the left from DD to D
2
D
2
shows a decrease in demand and
will have the following effects an equilibrium price and quantity.
(i) Equilibrium point shifts downwards to the left from E to E
2
.
(ii) Equilibrium price decreases from P
e
to P
e2
.
(ii) Equilibrium quantity decreases from Q
e
to Q
e2
Quantity demanded and supplied (Q) (kg)
Price (P) (Kshs)
P
e2
Q
e1
Q
e2
Q
e
D
2
O
D
D
1
D
2
D
D
1
P
e
P
e1
E
2
E
E
1
S
S
Fig 1.15: Eects of shift in a demand curve on equilibrium price and equilibrium quantity.
22
(b) Effects of a shift in a supply curve on equilibrium price and quantity
A shift in a curve is a change of the supply curve to a new location. This arises from
various factors. The effects of shift in a supply curve on equilibrium price and equilibrium
quantity. Assuming a normal supply curve SS, a shift of the supply curve to the right from
SS to S
1
S
1
shows an increase in supply and it has the following effects on equilibrium price
and equilibrium quantity.
(i) Equilibrium point shifts downwards to the right from E to E
1
.
(ii) Equilibrium price decreases downwards from P
e
to P
e1
.
(iii) Equilibrium quantity increases from Q
e
to Q
e1
A shift of the supply curve to the left from SS to S
2
S
2
has the following eects on
equilibrium price and equilibrium quantity.
(i) Equilibrium point shifts upwards to the left from E to E
2
.
(ii) Equilibrium price increases from P
e
to P
e2
(iii) Equilibrium quantity decreases from Q
e
to Q
e2
.
Quantity demanded and supplied (Q) (kg)
Price (P) (Kshs)
P
e1
Q
e1
Q
e2
Q
e
O
D
D
P
e
P
e2
E
2
E
E
1
S
S
S
2
S
2
S
1
S
1
Fig 1.16: Eects of shift in a supply curve on equilibrium price and equilibrium quantity.
23
Effects of simultaneous shift in a demand and supply curve on
equilibrium price and equilibrium quantity
(a) Effects of an increase in demand and supply curve on equilibrium price and
equilibrium quantity
A shift of the demand curve from DD to D
1
D
1
followed with a shift of the supply curve
from SS to S
1
S
1
has the following effects:
(i) Equilibrium point shifts upwards to the left from E to E
1
.
(ii) Equilibrium price P
e
increases from P
e
to P
e1
.
(iii) Equilibrium quantity Q increases from Q
e
to Q
e1
.
Quantity demanded and supplied (Q) (kg)
Price (P) (Kshs)
P
e
Q
e1
Q
e
O
D
D
P
e1
E
E
1
S
S
S
1
S
1
D
1
D
1
Fig 1.17: When both demand and supply increase.
(b) Effects of an increase in supply and decrease in demand on equilibrium price
and equilibrium quantity
A shift of the demand curve from DD to D
1
D
1
followed by a shift of the supply curve from
SS to S
1
S
1
has the following effects.
(i) Equilibrium points shifts from E to E
1
.
(ii) Equilibrium price P
e
decreases to P
e1
.
(iii) Equilibrium quantity increases from Q
e
to Q
e1
.
24
(c) Effects on equilibrium price and quantity when supply decreases and demand
also reduces
When supply decreases and demand also reduces. A shift of the demand curve from DD
to D
1
D
1
followed by a shift of the supply curve from SS to S
1
S
1
has the following effects:
(i) Equilibrium price remains unchanged at Pe.
(ii) Equilibrium quantity shifts to the left from E to E
1
.
(iii) Equilibrium quantity decreases from Q
e
to Q
e1
.
Quantity demanded and supplied (Q) (kg)
Price (P) (Kshs)
P
e
Q
e1
Q
e
O
D
D
E
E
1
S
S
S
1
S
1
D
1
D
1
Fig 1.19: When supply decreases, demand also reduces.
Other methods of determining price of a product
The forces of demand and supply are the major determinants of the market price of
commodities. The other factors that may determine the price in the market are:
(a) Government policy
(b) Haggling (bargaining)
(c) Auctioning (Bidding)
(d) Tendering/ Procurement
(a) Government policy
The government can inuence the price at which a commodity should be sold in the
market through the following ways:
(i) Price control
Although it is nowadays not very common as a result of liberalisation, the government
mayxthepriceatwhichacommodityshouldbesoldinthemarket.
(ii) Taxation
Tax levied on commodities sold or produced has an effect on the price charged. A high
tax leads to high prices while low tax or withdrawal of tax leads to low price. For example,
high tax imposed on imported goods such as second hand (mitumba) clothes leads to high
prices while low tax on clothes results in low prices.
25
(iii) Subsidy
Thisisanassistancegiventoproducerswhethernancialormaterial.Ithastheeffect
of lowering production costs in effect lowering commodity prices. The withdrawal of a
subsidy automatically leads to an increase in price of a product. For example, in the year
2017, the government gave maize millers a subsidy on cost of buying maize leading to
reductioninpriceofmaizeourtoconsumers.
(iv) Price regulation
The government may establish regulations to guide the determination of prices of certain
goods e.g. by determining the highest or lowest price limits. In Kenya, the Ministry of
Energy regulates the price of petroleum products such as diesel, petrol, lubricants and tar.
(b) Haggling/Bargaining
This involves persistent discussion of the price between the buyer and the seller until both
parties agree on the price to be charged.
(c) Auctioning/Bidding
This is a method of determining the price at which a commodity is to be sold in the
market. Buyers are given a chance to suggest a price at which they are willing to buy a
product. The buyers bid or quote different prices and the highest bidder is allowed to buy.
(d) Tendering/Procurement
This is a case where buyer invites prospective suppliers to express interest in supplying
goods or services to the buyer and the price at which they are willing to supply. Usually
the buyer selects the supplier who quotes the lowest price to supply goods or services.
Exercise 1.3
1. (a) Denethetermequilibriumpriceandequilibriumquantity.
(b) With the help of a diagram, show how equilibrium price and quantiy for
any given product is determined.
2. (a) Denethefollowingconcepts:
(i) Excess demand
(ii) Excess supply
(b) State what causes each of them.
26
Case Study
Jane Mwana lives close to Luanda market, one of the biggest open air market in Western
province. One afternoon, she decided to take a stroll to the market with her two daughters.
At the market, the two daughters were excited about the wide variety of goods they saw
being sold. The goods ranged from new clothes to old second hand clothes of all sizes,
shoes, foodstuffs, watches and many household items. Mary, the younger of the two, kept
pestering her mother to buy for her almost every item she saw and admired. In the same
market, there were so many people such that one could hardly pass without rubbing
shoulders with another. Rose, the older child told her mother that there were so many
people in the market that all the sellers will sell all their goods and go home with a lot of
money.
Questions
(i) Explain why you think that Rose’s comment was not true.
(ii) In the market place, Jane and her two children noticed many goods being sold. The
children’s clothes were among the goods being sold. Outline the factors that would
affect the demand for children’s clothes in Luanda market.
(iii) The total demand for bananas in the Luanda open market is 10,000 units per month
at a price of Ksh 120 per unit. Explain how this demand would behave if:
(a) The price of bananas fell by half.
(b) The area is one of those that has high incidences of the HIV and AIDS
pandemic.
Revision Questions
1. Explain four methods of determining price of a commodity other than the forces
of demand and supply.
2. Explain factors that may account for an increase in demand for a given product.
3. Explainhowthegovernmentcaninuencepriceofacommodity.
4. Explain the factors that may reduce the demand for a product.
27
2 2
The concept of a rm and an industry
A rm is a single business unit or enterprise under one ownership,
management and contract. Formed with objective of producing
goods or services for sale at a prot e.g. Mumias Sugar company,
Nzoia Sugar Company.
An industry is made up of several rms that compete in the
production of the same product or service. An industry may also
be made up of a single rm, two rms or very many rms. For
example, the sugar manufacturing industry in Kenya, is made
up of a few rms including Mumias Sugar Company Ltd, Sony
Sugar Company Ltd, Chemilil and Muhoroni. The transport
industry in Kenya is made up of very many vehicle operators
such as buses, matatus, boda boda, trains and aeroplanes.
Specic Objectives
By end of this topic, the learner should be able to:
(a) Distinguishbetweenarmandanindustry;
(b) Discussthe factors whichinuence the decision on
what goods and services to produce;
(c) Describethecriteriaofdeterminingthesizeof arm;
(d) Explainthefactorsthatinuencethelocationofarm;
(e) Discuss advantages and disadvantages of localisation
anddelocalisationofrms;
(f) Discuss the economics and diseconomies of scale;
(g) Justifythereasonsforexistenceof smallrms;
(h) Discuss the implications of production activities on the
environment and community health;
(i) Recognise the need for maintaining a healthy
environment.
Size and Location of
a Firm
28
Fig 2.1: Boda boda and vehicles are part of the transport industry.
Factors that determine the decision on what goods and services to produce include:
(i) Demand patterns
Firms produce goods whose demand is high since there is likelihood of making more
revenue.
(ii) Government policy
Favourable government policies sucha as reduced taxes lead to reduction in cost of
production thus would encourage more rms to produce such goods or services.
(iii) Level of competition
Firms would choose to invest in the production of goods and services where there is less
competitionhencethereisalikelihoodofmakingmoreprots.
(iv) Level of technology
Some products can only be produced through sophisticated techniques which some
rms may not aord. A rm will choose products that it can produce easily with its
level of technology.
(v) Availability of factors of production
Production of goods and services depend on the factors of production such as land,
labour and capital. When certain factors are not available, it becomes very costly to
produce some products causing rms to avoid investing in the production of such
goods or services due to perceived low prots..
(vi) Social – Cultural factors
These are factors that have to do with people’s beliefs and aitudes. What a rm
produces must agree with the beliefs and aitudes of the owners. For example, if the
owners of the rm are Muslims, they may not allow the rm to engage in pig farming.
29
(vii) Economic factors
An economic factor such as increased taxation have effect of increasing cost of
production which lowers prot margin. This will discourage a rm from investing
in production such goods or services.
(viii) Profitability of the venture
Prot maximisation is the main objective of every rm. Firms will decide to produce
goods and services that generate more prot than those that do not give surety on
future prots.
(ix) Environmental factors
In Kenya, National Environmental Authority(NEMA) discourage productions of
goods that are not friendly to the environment. Firms will therefore avoid investing in
production of such products.
Determining the size of a rm
Firms vary in size greatly. While some are small in size, others are said to be large in
size. The criteria used to compare the sizes of rms also vary greatly. The following
factors can be used as basis of determining the size of a rm:
(a) The amount of capital invested in the business
The total amount of capital invested in a business is known as the capital employed.
A business with a large amount of capital employed is said to be large in size while a
business where the capital employed is less is said to be small in size.
(b) The number of workers employed
Usually a large scale business tends to employ a large number of workers varying
in terms of skill from unskilled, semi-skilled to highly skilled. A small scale business
may have only a few employees.
(c) The value of output or total sales
The value of the goods produced and the total volume of sales made in a year can also
be used as an indicator of the size of the business. The total volume of sales is also
known as the turnover. A business that has a large turnover at the end of the year is
likely to be large in size, while a business with a small turnover over the same year is
likely to be small in size.
(d) Amount of profit generated
The amount of prot made by a business is also an indicator of the size of the business.
Under normal circumstances, large scale businesses would make high amounts of
prot while the small scale business would make low prot.
(e) Geographical area covered and number of branches
Large scale businesses tend to occupy a large geographical area and have many
branches nationally and even internationally. Small scale businesses on the other hand
tend to be small in terms of geographical area and may have no branches or only a
few. However, this alone cannot be a good basis to compare sizes of rms. There are
some businesses which may have no branch or only very few branches and occupy a
relatively small geographical area.
30
Location of a rm
The physical place where the business operates is called its location. Enterpreneurs
will choose a location that gives the lowest cost but high prots.
Factors inuencing the location of a rm include:
(a) The cost of land
Land is required for expansion and production of commodities. Some rms require
certain types of land in order to produce goods like cash crops while others simply
require space for selling products close to the market. Where the market is mainly
in the urban centres, the rms may prefer land close to the market. On the other hand
where the market is widespread, the rm may be located where the cost of land is low.
(b) Nearest to the source of raw materials
Raw materials must be transported to the factory for processing, Firms will be located
near the source of raw materials when:
(i) Raw materials are perishable to ensure they reach the factory while still fresh.
(ii) Raw materials are heavy and bulky to reduce transport costs.
(iii) Thermwouldwanttohavefullcontroloverthesupplyofrawmaterialstominimize
competition.
(iv) Thermwantstohaveconstantsupplyof rawmaterialstoensurecontinuousof 
goods.
(c) Accessibility to markets
A rm will be located near the market for its products when:
(i) Thenalproductisheavyorbulkytoreducetransportcoststothemarket
(ii) Thenalgoodisveryperishableandthecustomersinsistonbuyingwhenfresh
(iii) There is need to have full control over the market to be able to sell more goods
(iv) Thenalproductisveryfragilehenceneedtoavoiddamagetogoodswhichmay
reduceprots
(d) Accessibility to good transport network
A good transport network facilitates timely:
i) Transportation of raw materials to the factory
ii) Movement of nished goods to the market
iii) Movement of customers to the market
iv) Movement of workers to the rm
v) Accessibility to tertiary services such as banking and insurance
(e) Government policies
Thegovernmentformulatespoliciesdesignedtoencouragelocationofrmsinparticular
areas. Such policies may include:
(i) Reductionof taxesonrmsthatarelocatedwithincertainregions
31
(ii) Offeringsubsidiestoproducersinformof nanceandmaterials
(iii) Improving infrastructure in various regions
(iv) OfferingfreelandtormssuchastheExportProcessingZones(EPZ)inKitengela.
Thereforethelocationofarmmaybeinuencedbypolicy
(f) Availability and cost of labour
Firms require both skilled and unskilled labour for daily operations. Most rms are
located in urban centres where labour supply is abundant. In some places, the cost of
hiring labour is very high and this may discourage location of a rm in such places.
(g) Cost of power supply
Firms that require power to run heavy machinery and equipment will be located near
a steady supply of power. For example, a rm that uses petroleum as its main source
of power would be located near a steady supply of petrol. However for rms that uses
electricity, the location will be determined by the accesiblity of power supply.
(h) Availability of social amenities
Facilities such as schools, health centres and recreational centres aract skilled labour
force. Most of these facilities are in towns. This explains why regions with social
amenities aract location of more rms than those that do not have.
(i) Environmental factors
Productivity of some rms can be aected by environmental factors such as weather
change. For example, a tourist rm may be located in a place that is very aractive to
tourists due to favourable environmental conditions.
(j) Availability of water
Firms require water for domestic and production activities. Some places are endowed
with constant supply of water while certain regions experience poor water supply.
Most rms will want to be located where there is a good water supply.
(k) Provision of security
Security services are provided by the police force through establishment of police
stations and police patrols. This helps to maintain law and order and reduces incidence
of crime. This explains why most rms are located in urban centres where security
services are well provided.
(l) Room for expansion
Most rms begin as small scale rms and grow with time. Such rms will choose a
location where there is room for expansion.
32
THE
FIRM
Source of raw
materials
Room for
expansion
Nearness to
markets
Access to
transport
Availability of and
cost of labour
Government
policy
Cost and
availability of
power supply
Availability of
water supply
Provision of
security
Cost of land
Environment
factors
Availability of
social amenities
Fig 2.4: Summary of factors that influnce the location of a firm.
Localisation and delocalisation of rms in an economy
Localisation of rms in an economy
Localisation is concentration of rms in a particular location. For example, the
industrial area in Nairobi has a high concentration of rms producing various types
of goods and services. Localisation of rms is inuenced by the following factors:
(i) Well developed infrastructure such as transport and communication.
(ii) Governmentpolicythatinuencesrmstobelocatedinagivenregion.
(iii) Size and distribution of population in the area.
(iv) Availability of market for goods or services.
(v) Interdependenceof rmswherebyproductsof onermareusedasrawmaterials
by another.
Advantages of localisation
i) Development of a pool of labour
This leads t high concentration of workers in one place resulting to availability of all
types of labour, skilled and unskilled.
33
ii) Attracts subsidiary industries
Localisation attracts other businesses that support trading and production activities
such as banks, transport and insurance services.
iii) Management of waste products
 Somermsdisposetheirwasteproductsbysellingthemtoothersforrecycling.
Forexample,sawdustisaby-productofwoodwhichcanbeusedbyotherrmsto
produce softboard.
(iv) Creation of employment opportunities
 Differentemploymentopportunitiesarecreatedbyahighconcentrationof rmsand
the auxiliary services leads to creation of job opportunities for all levels of labour.
(vi) Development of social amenities
Facilities like health centres, schools and recreational centres develop in an area
concentratedwithrms.Theexistingamenitiesarealsoimprovedleadingtohigh
standards of living.
(vii) Establishment of better infrastructure
 A high concentration of rms in a locality promotes thedevelopment of better
infrastructure either by the government or the private sector. This facilitates
development of transport communication and security services.
Disadvantages of localisation
i) Imbalanced regional development
Better infrastructure, social amenities and creation of different job opportunities
in one region may mean that other regions are under developed. This will lead to
unequitable regional development in the country.
ii) Environmental degradation
 When several rms are located in oneplace,there will be destruction of the
environment through activities like:
(a) Emission of gases and gases into the atmosphere.
(b) Discharge of industrial wastes into rivers leading to water pollution.
(c) Excavation and mining activities leading to soil erosion.
(d) Deforestation resulting from clearing land to provide for expansion of
industries which may lead to desertication.
(iii) Rural-urban migration
Localisation is common in most urban areas. This provides better employment
opportunities in urban centres leading to a large movement of people from rural
areas to urban areas. This leaves the rural area with unskilled labour force who cannot
undertake development activities.
(iv) Shortage of facilities
 Theexpansionandgrowthof differentrmsinthesameplacemaycreatepressure
onexistingfacilities.Thismayleadtoanincreaseinrent,rates,rationingandtrafc
congestion.
34
(v) Social problems
Social problems associated with localisation include congestion in social places,
increased rate of crime, spread of diseases like HIV/AIDS and housing problems
which leads to establishment of slums.
Fig 2.5: Establishment of slums is caused by localisation of rms.
(vii) High rate of unemployment
The rural-urban migration leads to more people being attracted to these areas leading
to high rate of unemployment.
Delocalisation of rms in an economy
Delocalisation is the dispersion or establishment of rms in dierent places within the
country. It is usually done through established government policies such as:
(i) Offering land at cheaper prices or freely to attaract investors
(ii) Taxconcessions.Forexample,landgiventoExportProcessingZones(EPZ),tax
holidays, tax rebates and low tax rates to investors.
(iii) Improvedinfrastructuresliketransportnetwork,electrication,provisionof water
and communication facilities. An example is the infrastracture being put up by the
government to develop Konza City under Vision 2030.
(iv) Development of human resources and improvement of skills in the rural areas This
isachievedbytheestablishmentoftraininginspecicareas.
(vi) Government directives. Investors may be deliberately directed by the government
toestablishrmsinstatedplaces.
Advantages of delocalisation of rms
(i) Balanced regional development
Delocalisation encourages the even spread of auxiliary facilities across the country.
The government and other private bodies will also upgrade the infrastructural
facilities in all parts of the country.
(ii) Provision of equitable employment opportunities
 The  spread of  rms in all partsof the country will lead to more andequitable
distribution of employment opportunities in the country.
35
(iii) Reduction of social problems
Delocalisation reduces congestion of people in urban centres leading to a reduction
in social problems such as lack of housing, spread of diseases and prostitution.
(iv) Reduced rural urban migration
Delocalisation increases job opportunities in rural areas hence discouraging people
to move from rural to urban centres in search of employment.
(v) Exploitation of idle resources
 Distributionof rmsencouragestheuseofresourceswithinanareawhichwould
otherwise remain idle. This will lead to faster economic development in the country.
(vi) Reduction of insecurity
Reduces risks that may arise through acts of terrorism and war that may lead to large
scale destruction of property.
(vii) Improved standards of living
People in all areas will experience high incomes because they will have market for
their goods and at the same time they will have employment opportunities.
Disadvantages of delocalisation
(i) Delocalisationof rmsforcesthegovernmenttouseextrafundstolurermsintothe
rural areas. The government is also forced to spend more in improving infrastructure.
(ii) Inadequate resources in some areas especially skilled manpower may increase costs
ofproduction.Forexamplermsmaybeforcedtopaymoretotheskilledworkers
in the rural area experiencing hardships.
(iii) Itsupressescompetitionthereforeencouraginginefciencyinproductionof goods
and services.
Economies and diseconomies of scale
Economies of scale
These are the advantages enjoyed by a rm as a result of operating on large scale. They
are also known as the benets of large scale operations. These benets usually lower
the cost of production in a rm. The economies of scale are generally divided into two
categories namely:
(i) Internal economies of scale
(ii) External economies of scale
(i) Internal economies of scale
These are benets experienced by a single rm as a result of increasing its scale
of production. These benets are not shared by other rms in the industry. Internal
economies of scale simply occurs to a rm that has high level of output. It consists of
the following:
36
(a) Technical economies
Large scale rms are able to buy machinery and equipment needed in the production
process. They are also able to hire dierent labour force that ensures that there is
specialisation and division of labour. Technical economies therefore arise from
mechanisation and specialisation in the production process.
Fig 2.2 : Machine milking; technical benets arise from the use of machines in the production process.
(b) Managerial economies
Large scale rms have the ability to employ competent managers. They are also able
to create departments which improves eciency in rms.
(c) Financial economies
Large-scale rms have the security needed for borrowing loans. As a rm increases
its output, it will be in a position to obtain large amount of funds from nancial
institutions at lower cost.
(d) Marketing economies
Large scale rms have adequate nancial resources to invest in modern and agressive
methods of production such as advertising. This creates a high demand leading to
high sales.
37
Fig 2.3: Product promotions; it leads to increased sales.
(e) Research economies
Large scale rms are able to nance research in cheaper production techniques
leading to lower costs of production and high prot margins.
(f) Welfare economies
Large scale rms are able to provide workers with proper housing, sponsored
holidays for sta families, beer health care facilities and beer retirement benets.
All these improves the morale and eciency of the workers in a rm.
(g) Risk bearing economies
Largescalermsalwaysdiversifytheirsourcesof incomebycreatingmoremarkets
for their products and producing on a large scale to meet the demand. This means
failureononemarketcanbecompensatedbyothermarkets.Alsolargescalermsare
able to counter trading risks through large scale operations.
(h) Transport and storage ecomonies of scale
Large scale rms have their own transport and storage facilities. This reduces the
cost of transporting raw materials and nished products and also storing them.
The reduction of the cost of the resources leads to a high output and more prots.
(ii) External economies
Thesearethebenetsenjoyedbyarmasaresultof theexpansionorgrowthof 
theindustry.Theexternaleconomiesof scalearesharedwithotherrmsoperating
withintheindustry.Thesebenetsinclude:
(a) Development of a pool of labour force
 Asanindustryexpandspeopletendtotraininordertobeabsorbedbytherms.
Thiscreateshighlyqualiedlabourforcewhoarehiredbytherms.Thisleads
toreducedcostonlabourandincreaseprot.
(b) Development of subsidiary industries
 Thesermswillcomeuptoeitherprovidingrawmaterialstoexistingindustries,
38
providemarketfornishedproductsorofferservices.Thiswillleadtoincreased
protsbecauseofavailablemarketandservicessuchasbankingandinsurance..
(c) Development of social amenities
As an industry expands, facilities like schools, hospitals and stadiums are established
to serve the people. For example, workers can get access to such schools and acquire
skillsandknowledgethatwillincreasetheirefciencyatwork.
(d) Establishment of better infrastructure
 Thegrowthandexpansionof theindustryfacilitatesmarshallingofresourcessufcient
to undertake improvement of infrastructure such as transport and communication
services.Goodroadsandimprovedcommunicationserviceswillbenetrmsin
transportingrawmaterialsandnishedproductsaswellascommunicatingwithin
andwithouttherm.
(e) Better management of waste products
The expansion or growth of an industry willl provide either a market for its waste
products or facilitate the pooling of resources to manage waste. This will therefore
reducethecostof  waste productdisposal to an individualrm and increase the
market.
Diseconomies of scale
These are the disadvantages experienced  by rms that are operating on large scale.
They are also referred to as the disadvantages of large scale operation. Diseconomies of
scaleleadtohighcostsofproductioninrelationtotherevenueorprotsobtained.The
diseconomies of scale are also divided into two categories namely;
(a) Internal diseconomies of scale
(b) External diseconomies of scale
(a) Internal diseconomies of scale
Thesearethedisadvantagesorproblemsfacedbyarmoperatingonlargescale.These
disadvantagesareonlyexperiencebyasinglermandtheyarenotsharedbyotherrms
in the industry. They include:
(i) Managerial diseconomies of scale
Asarmgrowsinsize,therelationshipbetweenthemanagementandtheworkers
increasingly becomes poor such that the existence or absence of the top management
isinsignicanttotheworker.Suchworkerstendtoloseidentityandcommitmentto
thecompany.Thisleadstoreducedmotivationandefciencyof workers.
(ii) Bureaucracy
Largescalermssufferfromslowdecisionmaking.Thebureaucraticprocedures
involved in decision making slows down production activities. Failure to make prompt
decisionmaymakethermstoincurrlossesleadingtoincreasedcosts.
(ii) High overhead costs
Asarmexpandsitbeginstoexperienceanincreaseincostsofproduction,marketing
andlabour.Thisisbecauseitbecomesverydifcultforthemanagerstocontrolmany
activitiesdoneinarmoperatingonlargescale.
39
(iii) Wastage
Inalargescalerm,closesupervisionof materialsandotherinputsmaynotbe
effectively done. This will give rise to misuse and loss of materials. Machines also
may not be fully maintained and used. This will lead to the rise of materials cost and
inturnreduceprots.
(b) External diseconomies of scale
These are the disadvantages experienced by all the rms within an industry as a result
of its expansion. These problems or disadvantages are therefore shared by the rms.
They include:
(i) Shortage of land
 Astheindustryexpandsvariousrelatedrmswillberequiredtopaymoreinorderto
acquireland.Thecostoflandwillbeveryhighaseachrmstrugglestogetmore.
Thisleadstoincreasedcostofproductionanddecreasesprots.
(ii) Shortage of labour
 Astheindustryexpands,thermswillbegintocompeteforavailableskilledlabour.
This will lead to high cost of labour in terms of high wages and salaries. Shortage of
labourleadstodelaysinproductionandlowprots
(iii) Shortage of raw materials
 Thermsexperiencingdiseconomiesof scalewithintheindustrywillbecompeting
for the available raw materials. This forces the prices of raw materials to rise up
sharply and therefore increase the cost of production.
(iv) Congestion
 Inanindustryexperiencingdiseconomiesof largescale,rmswillbechallegedby
the shortage of infrastructure facilities and social amenities. This will mean that the
cost of transport and communication will be very high and this will lead to high cost
of production.
Existence of small scale rms in an economy
The advantages enjoyed by large scale rms over small scale rms, in any economy
does not prevent small scale rms from existing. Small scale rms have continued to
exist as a result of the following:
(i) Personal attention
Somesmallscalermsofferpersonalisedservicestotheircustomers.Theseservices
provide customer satisfaction. For example, hair dressing services are offered better
when they are small scale.
(ii) Size of the market
Sometimes, the market to be served is too small that it becomes uneconomical for
largescalermstoserveit.Suchmarketsarethereforebestservedbysmallscale
rms.
(ii) Government policy
In some countries the laws governing expansion of businesses are very strict. Small
40
scalermsmaynditdifculttomeettheconditions.Thegovernmentof Kenya
providessupportprogrammessuchasnancingtosmallscalerms.
(iii) Management
 Smallscalermsareeasiertomanage.Theymakedecisionsveryfastandefciently
since it is done by few people.
(iv) Flexibility
 Smallscalermsaremoreexibleandadaptabletochangesinthemarket.They
can change according to demand pattern. This can be achieved through changing
from providing certain goods or services.
(v) Control on production
 Smallrmseasilycontrolproductionbyproducinggoodsaccordingtodemandand
thereforeexpansionisjustiedbygrowthinconsumption.
(vi) Fear of rising costs
 Somesmall scale rms simply fearthe rising costs associated with large scale
production.Whensmallscalermexpandtheownersmaystartexperiencingan
increase in operating cost. This may force them to retain the business as small scale.
(vii) Nature of goods and services
Certain products are such that they cannot be produced in large quantities. These
products are best produced in small scale. For example, hair dressing, legal and
medical services.
Fig 2.4: Large scale rms have their own means of transport and storage facilities.
41
Fig 2.6: Hair dressing services are provided in small scale.
(viii) Sub-contracting
 Inspecialisedindustriessuchasconstructionindustry,smallscalermssurviveby
sub-contractingfromlargescalerms,therebybeingabletoservicelargescalerms.
Exercise 2.1
1. Statevefactorsthatwoulddeterminethesizeofarm.
2. Namefourfactorsthatwoulddeterminelocationof arm.
3. Listtwoexamplesof governmentpoliciesthatwouldaffectthelocationof arm.
4. Statethreeadvantagesof delocalisationofrmsinaneconomy.
5. (a) Distinguish between economies of scale and diseconomies of scale.
 (b) Explainvetypesofinternaleconomiesofscale.
6. Denetheconceptof delocalisationof rms.
7. Statevereasonswhybusinesspeoplecontinuetoownsmallrms
yet large businesses are the ones with economies of scale.
Implications of production activities on the environment and
community health
Firms engage in dierent activities in order to produce goods and services with a
major objective of maximising prots. These activities aect the environment and
human health in various ways:
42
The impact of production on the environment
1) Pollution
It is the resulting eect of releasing unwanted substances from industries into the
environment thereby contaminating it. A polluted environment is harmful to both
plant and animal life. Pollution occurs in the following ways:
(a) Air pollution
This is the release of unwanted gases, dust and smoke into the air. These pollutants
are mainly produced by industral plants, motor vehicles and burning of waste. Air
pollution has the following effects:
Fig 2.7: Burning of waste leads to air pollution.
(i) Respiratory problems: When the air is polluted, animals and human beings
breath in dangerous substances which are harmful to their life.
(ii) Green house eect: Gases such as carbon dioxide and methane when
released into the air create a blanket cover of the earth’s surface. This results
in warmth which is commonly referred to as global warming. Increased
temperature causes ice to melt leading to ooding.
(iii) Eects on ozone layer: The gases released into the air interfere with the
ozone layer. This allows rays of the sun to reach the atmosphere directly.
Firms that use chloroorocarbon (CFC) over many years interfere with
ozone layer.
43
(iv) Acid rain: It occurs when sulphur oxide gas is released into the atmosphere
the water becomes acid and therefore dangerous for use by human beings
and animals.
(b) Water pollution
This is caused by waste and by-products from industries released into rivers,
lakes, springs and oceans. Such waste products may dissolve in water leading to
contamination. Water pollution causes:
(i) Water-borne diseases such as cholera, diarrhoea and typhoid.
(ii) Death of sh and other water life.
(iii) Discolouration of water.
(iv) Foul smell/stench.
(c) Land pollution
This is the release of waste substances into or onto the land. It can be caused by
wastes from industries that manufacture products such as insecticides, herbicides,
articialfertilisersandotherconsumergoods.Thistypeof pollutionhasthefollowing
effects:
(i) Farming activities – The release of waste substances on the surface of the
earth interferes with crop farming and livestock keeping.
(ii) Dumping of waste hinders plant growth.
(iii) Accumulation of rubbish, dirt and waste become a breeding ground for pests
such as mice, rats, cockroaches and mosquitoes. These can cause diseases
like malaria, plague, cholera, typhoid and diarrhoea.
Fig 2.8: Land pollution from accumulated rubbish.
(iv) The erosion of soil can lead to blocked drainage and sewage systems.
(v) Destruction of habitats for animals or plants.
44
Fig 2.9: Waste products from industries destroy the environment.
(d) Noise pollution
Increase in production activities lead to more people and vehicles being attracted to
the urban centres. They make noise which is a form of noise pollution. Noise affects
the human hearing system and reduces human concentration in other activities.
The impact of production activities on community health
Just as production activities have destructive eect on the environment, they also
have serious destructive consequences on the community health. The consequences
on community health can be divided into two categories. These are:
• General poor public health.
• Environmental related diseases.
(a) General poor public health
The public constitute the labour force that plays the key role in production and
economic development activities. Most of the factors aecting the environment also
aect the health of the public. Workers involved in working in the industries and
factories are usually exposed to the eects of the industrial activities such as noise,
pollution, foul smell and many other environmental pollutants. Over time, the health
of these workers is aected and they become less productive.
(b) Environmental related diseases
Environmental related diseases that aect the community are mainly brought about
due to the eects of pollution and accumulation of dirt and rubbish. These diseases
include:
(i) Water-borne diseases
These are diseases that result from the contamination of water through pollution.
Such diseases include cholera, typhoid and diarrhoea.
45
(ii) Air-borne diseases
These are diseases that result from the contamination of the air brought about by
emission of gases, smoke and dust into the air. Such emissions arise from industries,
motor vehicles and cigarette smoking. These are responsible for diseases such as
tuberculosis, cancer of the lungs and pneumonia.
(iii) Pest-borne diseases
These diseases are brought about by infestation of the environment by various
pestssuchasrats,mice,cockroaches,iesandmosquitoes.Ratsandmicecause
plague.Cockroachesandiescausediseasessuchasdiarrhoeaandeyeinfections.
Mosquitoes, which breed in pools of stagnant water caused by dirt and blocked
drainage systems cause malaria.
Exercise 2.2
1. Denethetermpollution.
2. Distinguish between pollution and degradation.
3. State three causes of:
(i) air pollution.
(ii) water pollution.
(iii) soil pollution.
4. Stateveeffectsofpollution.
Revision Questions
1. Explainvereasonsthathaveledtothecontinuedexistenceof smallscalermsin
an economy.
2. Mentionvenegativeeffectsof pollutionontheenvironment.
3. Explainthefactorsthatdeterminethetypeof goodsandservicesarmshould
produce.
4. Explainthefactorsthatinuencelocationof arm.
5. Explainvereasonswhyarmwouldchooseonlocateitsproductionunitwhere
thereareotherrms.
6. Givefourcircumstanceswhichmayforcearmtobelocatednearthesiteofraw
materials.
7. Outlinefourproblemsassociatedwithhighconcentrationof rmsinalocality.
8. Discuss the implications of production activities on the environment and community
health.
Case Study
One Saturday afternoon, four form three students of Kakara High School visited Nguo
Bora Textiles, a large tailoring workshop in the market close to their school. This is the
shop where their school uniforms are bought. They were surprised by the number of
customers that came in and out.
46
Questions
1. WouldyouclassifyNguoBoraTextilesasarmoranindustry.Explainyouranswer.
2. Thermproducesandsellsawidevarietyof clothes.Explainthefactorsthatthe
rmconsidersbeforesettlingontheproductionofparticularclothes.
Practical Activity
For you to carry out this exercise, the teacher may divide your class into groups of ve
students. One group should choose and visit an industrial seing and the other visit
industries that are widely scaered.
Each group should:
(a) Attempttodistinguishbetweenanindustryandarm.
(b) Find out why some entrepreneurs have decided to either remain small or large size.
(c) Find out other economic activities that have been generated in the environment as
aresultofthepresenceof therms.
(d) Findouttheinuenceoftheindustryontheenvironmentandhumanhealth.
Your report should be tabulated as follows:
Type of
Business
Location: Concen-
trated or isolated
Reasons for
choice of
location
Other associated eco-
nomic activities
Choice of size: small/
large
Reasons for choice
of size
Inuence on physi-
cal environment/
human health
47
3 3
Meaning of a market
A market is the interaction of buyers and sellers with the objective
of exchanging goods and services for a particular price. These are
basically three elements of a market, namely;
i) Buyers
ii) Sellers
iii) The product
Though a market is not necessarily a physical place, it has ordinarily
beenidentiedaplacewherebuyersandsellersmeettoexchange
goods and services for money.
Meaning of product market
Product market is a market where buyers and sellers exchange goods
and services at a particular price.
Fig 3.1: Buyers and sellers meet to exchange goods and services in a market.
Specic objectives
By the end of this topic, the learner should be able to:
(a) Explain the meaning of a market;
(b) Explain the meaning of product market;
(c) Discuss the features of various types of product markets.
Product Markets
48
Types of product market structures
Market structure
Itreferstothevariouswaysmarketsareorganizedandtheirinuenceonpricesofgoods
and services.
There are four types product markets namely;
(a) perfect competition market structure
(b) monopoly market structure
(c) monopolistic competition market structure
(d) oligopoly market structure
(a) Perfect competition
This is an ideal situation where there are many rms, each producing only a small
fraction of the total output required in the market and none of the rms can inuence
the price in the market.
Characteristics or assumptions of perfect competition market
structure
(i) Many buyers and sellers
 Themarkethasmanyrmsthatsellasimilarcommodityinsmallquantities.The
actionof onesellercannotinuencethepriceinthemarket.Therearealsomany
buyers in the market who are disorganised. Thery buy a small quantity of a product
andcannotinuencethepriceinthemarket.
(ii) The commodity supplied is homogeneous or identical
The commodity sold in the market by all sellers are identical. The product or
commodity cannot be differentiated by factors such as size, quality, colour or texture.
(iii) Free entry and exit into the industry
Sellers and buyers are free to enter or exit the market. Sellers can supply any quantity
of the product to the market and leave at their will. Buyers are also allowed to enter,
buy any quantity that they may want and exit the market if they wish.
(iv) Perfect knowledge of the market
Buyers are assumed to have adequate knowledge about the market conditions that
can enable them to know where the price is fair. The sellers are also aware of what the
othersellersarechargingandtheprotthattheyaremaking.Thisthereforemeans
thatnoneofthemarketplayerscaninuencethepriceandoutputinthemarket.
(v) No government interference
It is assumed that there is no external intervention with the activities in the market.
For example, there is no price control or quantity control. This ensures that entry
and exit is voluntary and the market is controlled by supply and demand forces.
(vi) No preferential treatment of buyers or sellers
There is no discrimination in favour of either buyers or sellers on the basis of price,
quantity or quality. Buyers are not given preferential treatment in terms of price,
quantity or quality. Sellers also are not given preferential price for any quantity
supplied in the market other than the prevailing price.
49
(vii) No transport cost
Buyers and sellers are assumed to be located in the same place. There is no cost of
transport incurred by either sellers or buyers to and from the market.
(viii) Perfect mobility of factors of production
It is assumed that resources such as land, labour and capital can be easily moved
from one place to another.
(b) Monopoly market structure
This is a market structure with only one supplier who sells a product that has no close
substitutes.
Characteristics or assumptions under monopoly market structure
(i) Single supplier
 Singlesellerorrminthemarketprovidestotalsupplyof acommodity.Therm
thereforehastheabilitytoinuencethemarketbyreducingthequantitysupplied.
(ii) The product has no close substitutes
 Thesuppliersellsaproductthatdoesnothaveclosesubstitutes.Thereforetherm
does not face competition in the market.
(ii) There is no free entry into the industry
Firms are not free to join the industry. Barriers have been put in place to prevent other
rmsfromjoiningtheindustry.Thebarriersincludetotalcontroloverthesupplyof 
raw materials, government policy and technical knowledge about the industry.
Source of monopoly power
The sources of monopoly power includes:
(i) High initial cost of investment
This occurs where the initial cost of investment in the production of a commodity
isextremelyhighandonlyonermcanaffordtoinvest.KenyaPowerandLighting
CompanywhichistheonlyrmthatgenerateselectricityStandardGaugeRailway
(SGR) which provides railway transport services.
Fig. 3.2: Railway transport requires a high initial cost of investments.
50
(ii) Control resources
 Armmayhavetotalcontroloveraresourcelikeamineralore,potentialcompetitors
willnotbeable to acquire the rawmaterial.Therm is the onlysupplierof the
resourceandbarsothersfromenteringtherm.Forexample,KPLC(KenyaPower
and Lighting Company).
(iii) Ownership of production rights
 Thesearerightsthatprotectsasinglerminthemarket.Suchrightsincludepatent
rights,copyrightsandroyalties.Thermisgivenlegalprotectionorrightsbythe
governmentoranyotherbody.Thegovernmentmaylicenceonlyonermtoproduce
and supply a given product.
(iv) Total control over market
 The size of  the market may be too small to support severalrms protably. In
somesituationssomermsmayclosedownleavingonlyonermtooperateasa
monopolist.
(v) Amalgamation of competing firms
 Comingtogetherof competingrmsherebygivingthemmonopolypowersupplyof
goods or services. It may be *****.
(vi) Enjoyment of internal economies of scale
 Armmaybebenetingfromalargescaleproductiontotheextentthatitisableto
loweritspricesandstillmakesomeprots.Thismaypreventotherrmsfromeither
entering into the industry or the existing ones may simply leave because they may
not afford the high cost of producing on large scale.
(vii) Control over production technology
The technology required for the production of a product may only be with a single
rm.Ifthermisnotreadytosharetechnologywithotherrms,itwillremainasa
monopolist.
(c) Monopolistic competition
The structure falls in between perfect competition and monopoly structures.
Characteristics or assumptions under monopolistic competition
(i) Large number of sellers and buyers. Thishasmarketstructuresmanyrmsthatare
independent of each other. The buyers are also many and unorganised.
(ii) No barrier to entry into the industry or exit. Firms are free to enter or leave any time
they so wish.
(ii) Product differentiation.Thisisanattemptbyarmtomakeadifferenceinproduct
from those of its competitors. This is done through colour, packaging and advertising.
(iii) Perfect knowledge in the market. Where buyers are assumed to have perfect ****
(iv) The firms are the price determinant. As a result of product defferentiation, products
areuniqueandhencermsareabletodecidethecommodityprice.
Oligopoly
This is a market structure that is dominated by few rms that sell products which are
close substitutes. The rms are relatively large and each dominate a substantial part
51
of the market. A market structure with only two rms is called duopoly. For example,
Mastermind and British American Tobacco (BAT), Nation and Standard newspapers.
This type of market structure has the following features:
(i) Few sellers
 Thermswithintheindustryarefewbutproducecommoditiesinlargescale.The
productmayeitherbeidenticalordifferentiated.Oligopolistrmsthatsellidentical
products give rise to pure or perfect oligopoly. Imperfect oligopoly refers to the sell
of differentiated products.
(iii) Price is determined by the major competing firm
 Thisinterdependenceofrmsisinthefollowingways:
(a) Price wars: A situation in which rival rms undertake a series of price
reductions with an aim of cupturing a greater market. The rms keep on
watching the behaviour of the rival rms.
(b) Collusion: Firms in the industry come together in an agreement so as to
charge the same price.
(c) Cartel: This is formed when rms in an industry agree on market price and
market share openly and formally.
(d) Price leadership: This situation arises when one rm sets the price and other
watchful rms in the industry subsequently adapt the set price.
Revision Exercise 3.1
1. Denethefollowingterms:
(i) A market
(ii) Product market
(iii) Market structure
2. Describe the characteristics of a perfect competition market structure.
3. Distinguishbetweenarmandanindustry.
4. (a) NamethreermsinKenyawhichareoperatingasmonopolists.
 (b) Foreachoftheserms,statefourmajorreasonswhyyoubelievethatthey
are in a monopoly market.
5. Describecharacteristicsofrmsinmonopolisticcompetitionmarketstructure.
6. Denethetermoligopoly.
7. Explain three non-price competition methods.
8. Denethefollowingconcepts:
(a) Price leadership
(b) Collusion
52
Case Study
One afternoon Jack Omale drove to Matumbo Tosha open market in Ruiru where a
wide variety of products are sold. He was particularly interested in buying vegetables
and fruits. He noticed that most of the fruits particularly oranges, mangoes, and
tomatoes were being sold caught his aention. Every stall had a price that was similar
to the other. The stalls selling these products were very few indeed. Most potential
buyers like him were enquiring the price and walking away. According to him, these
products had been overpriced and none of the sellers was willing to lower the price.
Questions
(a) Identify the market structure in which the vegetables were being sold.
(b) Why was the vegetable prices so rigid?
(c) Do you think this rigidity is likely to prevail for long? Explain your answer.
Practical Activity
1. Your teacher should divide the class into four teams and each team should carry out
the following activities.
(a) Choose a suitable area to carry out the practical exercise. The area should be one
of the following:
(i) A shopping centre
(ii) A market centre
(iii) A township
(iv) A shopping complex
(b) The team should visit various businesses within the area in groups of at least two
students.Ineachgroup,thestudentsshouldndout:
(i) At least two businesses they can classify as monopoly and oligopoly.
(ii) In each case, the reasons for classifying each rm as such.
(iii) The essential considerations that each individual rm must be aware when
making price and output decisions.
(iv) The benets that accrue from operating in a monopoly and oligopoly.
(v) The problems experienced in operating in the above mentioned market
structures.
(v) The information gathered should be summarised in a table similar to the
one below:
Revision Questions
1. Distinguish between monopoly and monopolistic market structures.
2. State four features of a monopoly market structure.
3. Highlight four features that distinguish monopolistic competition from pure
monopoly.
4. Explainfourwaysinwhichamonopolyrmmaypreventotherrmsfromjoining
its industry.
53
1 1
Meaning of distribution
Distribution is the process of moving goods from the point of
production to the point of consumption. It is aimed at bridging the
gap between producers and consumers.
Channels of distribution
These are paths which products follow from the producer to the
nal consumer. It is also referred to as chain of distribution. It
creates place utility and adds value to a commodity. A chain of
distribution consists of: retailers, wholesalers, marketing boards
and agents as shown in Fig. 4.1 below.
Intermediaries in the distribution chain
These are institutions, businesses or individuals involved in the
distribution channel between the manufacturers or producers and
the nal consumers. They are also known as agents or middle
persons in the distribution channel. They transfer ownership of
goods and services by transporting them to the nal consumers.
Specic objectives
By the end of this topic, the learner should be able to:
(a) Explain the meaning of distribution;
(b) Describe the various channels of distribution;
(c) Discuss the role of intermediates in the distribution
chain;
(d) Discussthefactorswhichmayinuencechoiceof 
a distribution channel.
Chain of
Distribution
54
Types of intermediaries
Intermediaries are broadly grouped into two namely:
1) Merchant traders
2) Mercantile traders
Merchant traders
Merchant traders consist of wholesalers and relailers. They have the following features:
(a) They buy and sell on their own behalf by buying, taking possession of goods and
later selling them.
(b) Theyearnprotastheirrewardfortheirservices.
(c) They take risks in business and thus can suffer losses if the business fails.
(d) They work independently, that is without involving suppliers and producers of
goods or services. They are therefore not controlled by the suppliers.
Mercantile traders
They are traders who do not sell or buy goods on their own behalf but act on behald
of principals. These traders include brokers, factors, commission agents, del credere
agents, clearing and forwarding agents, underwriters and auctioneers. They have the
following features:
(a) They do not sell or buy on their own behalf but they act on behalf of suppliers of
goods who are principals.
(b) Theydonotearnprot,insteadtheyearncommission.
(c) They do not take risks and they do not suffer any loss if the business fails.
(d) They work dependently with producers. They are controlled by their suppliers.
(i) Brokers
These are mercantile traders, who represent a buyer or a seller in negotiating a
purchase or sale without physically handling the goods. Brokers receive a brokerage
commission for the services offered. Example are brokers in the stock exchange,
insurance brokers, motor vehicle brokers.
Fig 4.2: The Nairobi Stock Exchange brokers.
55
(ii) Factors
These are mercantile traders who sell goods or services on behalf of the principals.
They sell and receive payment in their own name and give authentic receipts. They
are paid discounts for their services.
(iii) Commission agents
These are traders employed by foreign merchants for a commission. They receive
orders from foreign buyers and also buy goods and services from the traders. They
transact business in their own names and prepare the necessary documentation for
export and import.
(iv) Del credere agents
These are traders that sell goods on behalf of a principal. They bear all the risks
that arise due to losses incurred in the cause of the business transactions. They earn
commission for the services rendered and the commission is based on the volume
of sales. They may be paid del credere commission which is over and above normal
commission for the extra risk of loss they bear for the services or goods they sell on
behalf of the principal.
(v) Clearing and forwarding agents
These are traders who act for exporters and importers. They collect and deliver
goods on behalf of the principal. They have knowledge of the customs formalities
and export and import procedures which enable them to clear and forward the goods.
These involve documentation and storage of goods imported or to be exported on
behalf of the principal.
(vi) Auctioneers
These are business organisations or individuals who organise to sell commodities at
a public auction. An auctioneer may act on his or her own behalf or on behalf of a
principal.Heorsheearnsaprotwhenheorsheactsonhisorherownbehalf.A
commisssion is earned when an auctioner sells a commodity on behalf of a principal.
The role of intermediaries in the distribution chain
Intermediaries play the following role in the distribution of various products:
(i) Provision of storage facilities
They provide warehousing services for the commodities they deal in until their
demand arises.
56
Fig 4.3: A warehouse; it stores goods until the demand arises.
(ii) Marketing and sales
Intermediaries assist producers in locating the market. They also assist in marketing
research as well as product promotion.
(iii) Breaking of bulk
Intermediaries buy goods in bulk from producers and sell to consumers in convenient
and smaller quantities.
(iv) Provision of transportation services
Some of the intermediaries provide physical transfer of commodities to their
destination. They provide trucks, lorries or containers to transport commodities to
their destinations on behalf of the owner or manufacturer.
(v) Facilitation on variety of goods and services
Intermediaries receive different types of goods from many suppliers and sell them
tonalconsumers.Thisisbecausetheyhaveknowledgeofdemandandtheyare
able to laise with producers to satisfy consumers’ needs.
57
Fig 4.4: Vehicle transporting goods to a destination.
(vi) Provision of financial services
Some intermediaries buy commodities in cash or bill of exchange from producers.
This enables producers to retain working capital. This in turn helps the producers
to keep up production and therefore ensure continuous supply of products in the
market.
(vii) Preparation of goods and services for sale
Some intermediaries undertake the task of branding, sorting, grading, packaging and
labeling of commodities ready for sale. The intermediaries will acquire a warehouse
where all these preparations can be done.
(viii) Offer credit facilities
Intermediaries allow credit facilities to their customers. This enables the customers
to acquire the goods they need before they are able to pay for them.
(ix) Stabilisation of prices
 Intermediariesstabilisepricesthroughcontrollingtheowofproducts.Whenthereis
over production, they store the excess and when there is less production, they release
goods from the stores. The storage of excess products and release of products in
timesofshortagediscouragespriceuctuationinthemarket.
(x) Taking risks
Intermediaries take the risks of storing goods, transporting them and selling to
the customers on credit. This ensures a continuous supply of commodities in the
market. The risks involved include; theft, accident, commodities going bad and price
uctuations.
58
Distribution of various products
Channels of distribution of various products can be put into three major categories:
(i) Agricultural commodities produced locally
(ii) Locally manufactured goods
(iii) Imported goods
1) Distribution of agricultural products
Channels of distribution of agricultural products is illustrated in the diagram given
below.
FARMER
Co-operative
society
Wholesaler
Retailer
Marketing
Board
Retailer
Wholesalers
Retailers
Retailers
>
>
>
>
>
>
>
>
>
>
>
>
CONSUMER
Fig. 4.5a: Chain of distribution for agricultural products.
Distribution of agricultural products.
Channel1
The farmer sells agricultural produce to the co-operative society which sells to the
wholesalersandwholesalerstoretailerswhointurnselltothenalconsumer.Example,
Dairy products such as milk, tea, coffee go through this type of channel.
Channel2
The farmer sells to the marketing board which produce to retailors. Retailor in turn sells
produce to consumer. Example, cereals, maize and beans.
Channel3
The farmer sells produce to wholesalers, who sell to the retailers. Retailer in turn sell
produce to the consumers.
Channel4
Farmers can directly sell their produce to consumers. Examples of such produce include:
milk, fruits and vegetables.
59
Channel5
The farmer can sell a particular produce to retailers who in turn sell the produce to
consumers.
It should be noted that a channel of distribution begins with the source of the goods
and ends with the consumer. The channel is shown by an arrow that indicates the
direction of ow of goods. For example, Farmer Co-operative society Wholesaler
Retailer Consumer.
2. Distribution of locally manufactured goods
These are goods manufactured within a country. Their distribution channels is
illustrated in the diagram given below.
MANUFACTURER
Manufacturer’s
Appointed
Agent
Wholesaler
>
>
>
>
>>
>
>
CONSUMER
Retailers
Retailers
Wholesaler
>
Fig. 4.5b: Chain of distribution for locally manufactured goods.
Distribution of locally manufuctured goods
channel1
The manufacturer sells goods to an appointed agent who in turn sells goods to the
consumer. Example is Bata Shoe Company which sells its goods through appointed agents
countrywide.
Channel2
The manufacturer sells locally manufactured goods to a wholesaler who in turn sell goods
to the consumer.
Channel3
The manufacturer sells goods to the wholesaler who sell goods to the retailer. The retailer
in turn sells goods to the consumer. Essential goods like sugar, our, beauty products
follow this channel.
Channel1-4
Themanufacturersellsgoodstotheretailerwhointurnsellsgoodstothenalconsumer,
examples including small scale businesses such as cloth making, furniture making and
Juakali products follow this channel.
60
3. Distribution of imported goods
These are goods which are produced outside the country but are sold in the local
market. The channel begins with the foreign exporter and ends with the local consumer
in the country where the goods are sold. The diagram below illustrates distribution
channel for imported goods.
Fig. 4.5c: Chain of distribution for imported goods.
EXPORTER
CONSUMER
Agent
Wholesaler
Manufacturer’s
representative
Wholesaler
Retailer
Retailer
Wholesaler
Retailer
Choosing a distribution channel
Some channels of distribution are short while others are long. The longer the channel
of distribution, the more expensive the commodity will sell to the nal consumer.
A producer should therefore consider the following factors when choosing an
appropriate channel of distribution.
(i) The value and technical nature of the product
Very expensive goods like ships and aircrafts are sold directly to consumers. Since
intermediaries may not have the appropriate knowledge skills to handle them. Highly
technical goods that require special installation and repair are also sold directly to
consumers.
(ii) Geographical distribution of consumers
If the consumers are concentrated within a small region, the producer may use a
channel that only targets them. On the other hand, if the consumers are evenly spread
within the country, then very long channels that involve more intermediaries may be
used.
(iii) Government policy
The distribution of certain goods depend on the existing government policy. If there
are laws governing the distribution of such products, the chain of distribution used
should be consistent with the government policy. For example, cereals are distributed
by the government through the National Cereals Produce Board
(iv) The type of intermediaries within the channel
Every channel of distribution has different types of intermediaries. A producer may
choose channels with very aggressive but expensive intermediaries.
61
(v) Scale of production
 Smallscalermspreferusingshorterchannelstodistributegoodsbecausetheyare
lesscostly.Largescalermsmayprefertouselargrchannelsbecausetheyhavea
wide geographical coverage.
(vi) The desired price of the product
Occasionally, the producer decides on the price at which a commodity should be sold
in the market. A producer will use a channel that ensures that the product is sold at
the desired price.
(vii) Fashion, taste and preferences
If a commodity, such as ladies’ clothes, is exposed to risks caused by changes in
fashion, it will need to be sold as fast as possible. This can be achieved by choosing
a shorter chain of distribution.
Exercise 4.1
1. Denetheterm‘distribution’.
2. Outlinevechannelsthatabananafarmercanusetodistributebananastothenal
consumer.
3. Denethetermchannelof distribution.
4 State six factors that determine the channel length.
5 Describe two categories of intermediaries and give relevant examples.
6. Outline the importance of intermediaries in a chain of distribution.
Case Study
Kahawa Company (K) Ltd. is an indigenous Kenyan company involved in the growing
and processing of coee. Kahawa Company has huge coee plantations in the Kenyan
highlands, producing for its own factories. The company applies modern technology
in farming in order to produce high quality coee which can compete eectively in
the liberalised world market. It also uses information and communication technology
in its marketing activities.
The company has a large market locally and within the East African countries
and the Common Market for Eastern and Southern African (COMESA) regions with
motivating preferential taris. However, the high production cost in terms of farm
implements, quality seeds and processing equipment, make Kenyan coee relatively
expensive in the market, hence, not competitive in the uctuating world market prices.
The major challenge is for the management to choose an appropriate chain of
distribution that will enhance aggressive marketing of coee to reduce marketing
risks and subsequently increase sales and retain the company in the market.
Questions
1. With the aid of a diagram, suggest a suitable chain of distribution for Kahawa Company
(K) Ltd.
2. Explain the factors that the company should consider when choosing an appropriate
chain of distribution.
3. Explain the importance of intermediaries in the distribution of processed coffee.
62
Practical Activity
Your teacher may divide the class into three teams; A, B, C. Each team should
be further sub-divided into smaller groups of not more than three students each. Each
team should work as follows:
1. Team A
Each group in the team is required to collect information and make a report on the
chain of distribution for agricultural products. The groups should be divided into
three categories as follows:
Category I: To collect information from the market place on the distribution chain for
agricultural products.
Category II: To visit and collect information from a business selling locally manufactured
goods.
Category III: To visit and collect information from a business selling imported
manufactured goods.
Each group should select at least three commodities to study. The groups
should visit at least three businesses selling goods to the nal consumer and
interview owners of the businesses. Record the information in a table similar
to the one given below. An example is given in the table.
Commodity
Stage I
Stages in the distribution of the commodity
Stage II
Stage III
1.Sukumawiki
Wholesaler buys and
collects from various
farmers.
Wholesaler sells to
another wholesaler in
a wholesale market.
Market wholesaler
sells to retailer who
inturnsellstonal
consumer.
2. Team B
Each group in this team should collect information on distribution chains of locally
manufactured goods.Each group in the team should select at least three types of
commodities. Record the information in a table similar to the one above.
3. Team C
Each group in this team should collect information on distribution chain of manufactured
imported goods. Record the information in a table similar to the one above.
After obtaining the information, each team should meet, compare notes and prepare a
report on the distribution channels for each commodity. The report should be presented
to the class.
63
Revision Questions
1. Explain factors that determine the choice of an appropriate channel of distribution.
2. With the aid of a diagram, describe the chain of distribution for agricultural goods.
3. Explain possible channels of distribution for cooking fat in Kenya.
4. Discuss the following intermediaries:
(i) Auctioneers
(ii) Brokers
(iii) Clearing and forwarding agents
(iv) Factors
(v) Del credere agents
(vi) Underwriters
64
5 5
Meaning of national income
National income is the total aggregate money of all the goods and
services produced in a country in a given period of time usually
one year. It can also be said to be the money value of total income
earned by consumers, (also called house holds) and producers,
(also called rms).  Producers produce goods and services while
consumers provide factors of production like land, labour, capital and
entrepreneurship.
National income can be determined using the following
approaches.
(i) Expenditure approachwheretotal expenditure by rms on
factors of production and expenditure by consumers on goods
and services. Expenditure is usually designated as E.
(ii) Income approach which provides the total income from factor
services provided byconsumers and rms. Total income is
usually designated as Y.
Specic objectives
By the end of this topic, the learner should be able to:
(a) Explain the meaning of national income;
(b) Describethecircularowofincome;
(c) Explain the methods of measuring national income;
(d) Explain the problems encountered in measuring national
income;
(e) Discuss the uses of national income statistics;
(f) Discussthefactorsthatinuencethelevelof national
income.
National Income
65
(iii) Outputapproachwhichprovidenetincomebyrmsandconsumersinaperiodof 
one year. Total output is designated as O.
This national income (Y) is equal to total expenditure (E) and total output (O)
O=Y=E
Terms used in national income
(a) Gross Domestic Product (GDP)
This is the market value of all goods and services produced in a country over a given
period; usually one year. It does not include the value of goods and services produced by
citizens living abroad.
(b) Net Domestic Product (NDP)
Net Domestic Product (NDP) is the total market value of goods and services produced
within a country (GDP) less depreciation. It can be expressed as:
Net Domestic Product = GDP - Total depreciation.
When producing goods and services, there is wear and tear of machines used in production,
also called capital consumption or simply depreciation.
(c) Net income from abroad
Itisthedifferencebetweentheowof incomeinacountry.Itisthedifferencebetweenthe
value of goods and services produced by citizens of a country living abroad and the value
of goods and services produced by foreigners living within the country.
(d) Gross national product (GNP)
It is the monetary value of all the goods and services produced within or outside the
country by citizens over a given period of time. It can be expressed as:
Gross National product (GNP)= Gross Domestic Product + Net income from abroad
(e) Net National Product (NNP)
This is the gross national product less capital consumption or depreciation. It is expressed
as:
GNP – Total depreciation = NNP
(f) National wealth
It is the total money value of real assets owned by citizens of a country within a given
period of time. It should be differentiated from national income which is the value of
goods and services produced by citizens over a period of time. For example, rental houses
constitute national wealth whereas rent accruing from rental houses constitute national
income.
The circular ow of income
Thisistheowof incomefromhouseholds(consumers)torms(producers)andthen
back to households in an economy.
Firms hire factors of production such as land, labour, capital and enterprenuership
from households. They pay households rent, salary, interest and prot. Firms use the
factors of production to produce goods and services which are then sold to households.
Households, in turn, will buy the goods and services produced and their income goes
to the rms.
66
The simplest type of the circular ow of income is that of a two-sector economy
which operates only in a closed economy. A two sector closed economy consists of
rms and households only. Such an economy is assumed to be self-sucient in every
way and therefore does not require any links with other countries. The diagram below
illustrates the circular ow of income in a two sector closed economy.
Payment for factors of production
Factors of production
Business Firms O = Y
E = Y Households
Goods and Services
Payments for the goods and services
Fig. 5.2: Circular ow of income in a two-sector closed economy.
The circular ow of income in a two sector economy works under the following
assumptions:
(i) Thattheeconomyisclosedanddoesnotbenetfromexportsorimports.
(ii) Thatthereareonlytwosectors;rmsandhouseholds.
(iii) Thatrmsspendalltheincomewhichtheyhavereceivedonproductionofgoods
and services.
(iv) That households spend all the income which they have received on goods and services.
(v) That there is no government intervention.
Equilibrium national income
Itisverydifcultforaneconomytoremainclosedwithoutimportsandexportsorwithout
governmentintervention.Householdsandrmsmaynotaswellspendalltheirincome
without any savings or investment. This means there will always be withdrawals and
injections.
Withdrawals also called leakages are those factors that reduces or removes the income
ofrmsandhouseholdsfromthecircularowincome.Examplesinclude:
(a) Government taxes–Someincomesof thermsandhouseholdsarereducedthrough
tax that is imposed by the government.
(b) Imports – These are goods and services bought from abroad. The price of imports is
usuallyhighandreducesincomeforrmsandhouseholds.
(c) Savings–Householdswillsavepartof theirincomewithnancialinstitutions.This
reduces the cash in hand, which is readily available for spending.
Injections into the circular ow of  income represents those factors that add onto the
incomeofhouseholdsandrms.Theyinclude:
67
(a) Investment
Thermswillusepartoftheirincomeonfurtherinvestment.Theywillalsoborrowfrom
nancialinstitutionstoinvestinsteadof producinggoodsandservices.Thisincreasesthe
incomeofhouseholdsandrms.
(b) Government expenditure
Any money spent by the government either on factors of production or on production of
goods and services increases the money or income.
(c) Exports
Thesearegoodsandservicessoldtoothercountries.Theyincreaseincometormsand
households.
Thediagrambelowillustratesinjectionsandwithdrawalsfromthecircularowof income
in a two sector closed economy.
Taxes (T)
Eports (X)
Saving (S)
Investments (I)
Imports (m)
Investment
expenditure (G)
Households
Firms
Fig 5.3: Equal injection and withdrawals leads to national income equilibrium.
Methods of measuring national income
As mentioned earlier, the total value of output of a country is equal to the total income
earned and is equal to all the expenditure on goods and services and on factors of
production. This means, output (O) = Income Y = Expenditure (E).
National income can therefore be measured using the following methods:
(a) The output method
(b) The income method
(c) The expenditure method
68
(a) The output method
This approach involves summing up the value of output of goods and services from all
rmsineverysectoroftheeconomyoveraperiodof oneyear.Caremustbetakennot
toaccountfortheoutputfromthermmorethanonce.Onlythenalgoodsandservices
should be taken into consideration.
To avoid double counting, only the value added at dierent stages of production
is added. For example, the production of maize our passes through the following
stages:
(i) Farmer produces maize.
(ii) Miller processes the our.
(iii) Distributors transport the our to the retailers.
(iv) Retailers sell the maize our to the customers.
(b) The income method
In this approach, all the individual income from factors of production due to services
rendered are obtained to compute national income. This includes wages, salaries, interest,
rent and prots. Only income from productive activities are added. Transfer earnings
likeretirementbenetsand student grantsarefromnon-productioveactivitiesandare
therefore excluded.
National Income Y = I + R + W+P
Where
I = Interest
R = Rent
W = Wages / Salaries
  P=Prots
(c) The expenditure method
In this approach, national income is obtained by calculating all forms of spending in the
country. Expenditure on intermediate goods are excluded. These are goods that are still
undergoing processing that is; they are raw materials. This is practised to avoid double
counting of such goods.
There are various types of expenditure considered in the calculation of national
income namely:
(i) Total expenditure on consumer goods abbreviated as C.
(ii) Total expenditure by the government, abbreviated as G
(iii) Total expenditure on capital goods, also called investment expenditure, abbreviated
as I.
National Income (NY) is therefore equal to C+ I + G
NY = C + I + G
Problems encountered in measuring national income
Each method used to measure national income has problems associated with it. The
problems can therefore be grouped into three as follows.
(i) Problems experienced when using the output method
a) Illegal activities
69
These are activities which are excluded but have money value. For example, the
production of hard drugs.
b) Changes in prices
 Thegoodsandservicesarevaluedatmarketpriceswhichkeeponuctuating.
c) Valuing subsistence production
These are goods and services produced for own consumption. Usually, they are not
taken into account but they have money value.
d) Valuing government output
It is not easy to measure the value of government output which does not reach the
market.
e) Inaccuracy of data statistics
The output approach can only be valid if the data used is correct. It is not easy to
obtain primary data especially from the informal sector like Jua kali.
(ii) Problems experienced when using the income method
a) Inaccurate statistical data
 Itisnoteasytoaccuratelyobtaindataonthecorrectincomeearned.Mostrmsdo
not reveal true records of their income.
b) Changing price
 Theincomeearnedespeciallybyrmsasprotdependverymuchonthepriceof 
the commodities which keeps on changing.
c) Illegal income earned
The income earned in the country in a year includes that from illegal activities which
is exchanged when computing national income.
d) Exclusion of transfer earnings
 Anyamountpaidfornon-productiveactivityshouldbeleftout.Thisgureisalways
not easy to compute.
e) Public income
It is not easy to obtain the correct total income earned by the government because
of political intervention.
(iii) Problems experienced when using the expenditure method
a) Valuation of export and imports
 Itisdifculttohaveauniformrateof exchangetobeusedinmeasuringnational
income.
b) Measuring expenditure by the private sector
The private sector is so diverse and informal that obtaining correct data is not easy.
c Double counting
 Onlyexpenditureonnalgoodsshouldbemeasuredbutthisisnoteasybecause
someintermediategoodsdonotbecomepartofthenalgood.
d Inaccurate data from the subsistence sector
The subsistence sector doesn’t record its expenditure making data inaccurate.
e Government expenditure
This is usually incorrect because of political interference.
Uses of national income statistics
National income statistics are used for the following purposes:
70
(i) Measuring of economic growth
National income estimate reveals the overall production performance of the economy
in a year. A general increase in national income over a period of time is an indicator of
economic growth as shown on table 5.1.
Time period 1984 1985 1986 1987
Gross National Product
(£ millions)
3150 3680 4250 4680
Population (millions) 15 16 17 18
Income per Capita (£) 210 230 250 260
Table 5.1: National income statistics are used to measure economic growth in a country.
(ii) Planning purpose
In order to plan for the public and private sectors of the economy, the government uses
national income statistics. National income statistics enable planners to establish an
efciencynetworkforcollectinginformationandprovidingabasisforfutureeconomic
planning policy.
(iii) Measuring the standard of living
In order to measure the general standard of living in a country, statistics can be used as a
measure of general standards of living in a country. High national income may imply high
standard of living.
(iv) Measuring the contribution of each sector of the economy to the development
of a country.
When computing national income statistics, data is drawn from all the sectors of the
economy, hence the contribution of each sector can be ascertained.
(v) Measuring distribution of income
National income statistics show the share of national income taken by wage earners and
property owners. It also shows the contribution of various regions to economic growth. It
can also show how much has been contributed by the working class both employees and
employers.
(vi) As an indicator to savings and investment in the economy
Statistics on savings, consumption and investment are necessary in assessing economic
growthandforplanningpurposes.Thelevelof consumptionreectthetotaloutputof 
consumergoodsandserviceswhilesavingsreectthelevelof investment.
(vii) For comparative purpose
National income statistics can be used to compare standards of living between different
countries. A country with a higher national income is said to have a high standard of
living. The use of a national income to measure the standard of living however, has the
following limitations:
(a) Degree of accuracy
 Thecomputationof nationalincomeguresdependsverymuchonthecompetence
of the statisticians. At times, the data collected and used is inaccurate. If the national
incomegureisinaccurate,itcannotbereliedupontocomparestandardsof living.
71
(b) Challanges in variation in price structures
 Countriessufferfromdifferentinationrates.Onecountry’snationalincomemaybe
veryhighbecauseithasusedstablemarketpricesthatarenotaffectedbyination.
Another country may use prices that are very unstable, thus giving a wrong impression.
(c) Problem of income distribution
National income statistics do not show how the income is shared by people in a
country. When there is a high inequality in income distribution, per capita income
may not show the different standards of living.
(d) Problem of different currencies and exchange rates
Each country calculates its national income in its local currency which is then
converted to the American dollar. Countries with stable currency usually have high
national income. Some countries record low national income statistics simply because
they have a low exchange rate against other currencies.
(e)** Hard work versus leisure
A high gross national product recorded under unhealthy conditions does not mean
that the people’s standard of living is high. Since some people may have denied
themselves leisure.
(f) Adverse environmental effects
A high national income of a country which is a destructor to the environment does
not mean that the standards of living of the people is high. Effects of pollution, for
instance,mayoutweighthebenetsofahighgrossdomesticproduct.
(h) Different priorities and preferences
Countries and citizens have different priorities and preferences. Some people consume
commodities which have a high money value, while others use commodities with a
low money value. A country that has given agriculture priority over industrialisation
like Kenya may record a low national income. Some countries spend a lot on
infrastructure in terms of transport and communication and they end up with a high
nationalincome.Itisthereforedifculttocomparethelivingstandardsof peopleof 
different countries.
(i) Climatic conditions
Regional differences in climatic conditions demand different types of houses built,
different clothes, work and even different kinds of food eaten. All these requirements
areexpensive.Acountrythatiswarmmayndherpeopleusingcheaphouses,food
and clothing giving the impression that the standard of living is low. Such differences
inexpendituremakeitdifculttogiveareliablecomparativeanalysisof different
countries.
Exercise 5.1
1. Denethetermincome.
2. Explain how the expenditure methods are used to calculate national income.
3. Explain problems faced in estimating national income.
72
Factors which inuence the level of national income
The level of national income refers to the size of a country’s national income. The following
aresomeofthefactorsthatinuencethelevelofnationalincomeof acountry.
(i) Size of the working population
This involves the structure and social attitude of the country’s population. It also involves
thequalityofitsworkforceintermsof trainingandqualication.If abigpercentageof 
the people have positive attitude towards work, then the output of the country will be
high. A country with a reasonable percentage of skilled labour force who are healthy and
productive, will record a high national income.
(ii) Political stability
Thissituationisnecessaryforbusinessactivitiestoourishinacountry.Politicalstability
encourages foreign investment and tourism activities. Peace and stability promote
condenceandencourageproduction,hencehighincomelevels.
(iii) Capital equipment
A country that uses modern sophisticated techniques will have a high level of national
income. Use of appropriate technology which puts into use a country’s resources also
increases output.
(iv) Terms of trade
This is the rate at which a country’s exports exchange with her imports. Countries with
favourable terms of trade always have high national income. When a country experiences
favourable terms of trade, it means more goods and services are exported and hence a
high national income.
(v) National resources
Thequantityandqualityof acountry’sresourcesinuenceshernationalincome.Some
countries that have resources like gold, oil, fertile soils, have high national incomes.
Countries which do not have much resources have low national income.
(vi) Foreign Investments
It refers to a country’s investments in other countries. Countries with a lot of foreign
investments are likely to have high national income because of the high net income from
abroad.
(vii) Enterprenuership
This the culture of citizens of a country to come up with business activities that create
wealth. Countries with an entreprenuership culture will have a high national income.
Exercise 5.2
1. Explain the importance of national income statistics in a country.
2. State the limitations of national income statistics in comparing the welfare of
different countries.
3. Outline the problems of using national income statistics to measure the social
welfare of the people of a country.
73
Practical activity
Your teacher will arrange to have students carry out research about national income
in the following areas.
(a)Denition of national income.
(b) How national income is measured.
(c) Why measure national income.
There will be three groups each consisting of not more than four students, each
group to be assigned a research topic. After carrying out the research each group to
prepare a report for presentation to the rest of the class.
Revision Questions
1. Describe the three methods used in measuring national income.
2. Outline the factors that determine the national income of a country.
3. Explain how each of the following may affect the national income:
(i) Increased private investment.
(ii) Increased government expenditure from taxation, loans and grants.
4. Explain why a rise in national income may not lead to improved standards of living
of the citizens of a country.
5. Explain the main problems encountered in estimating national income.
6. Describethecircularowofincomeinatwosectoreconomy.
7. Statethreeleakagesandthreewithdrawalsfromthecircularowofincome.
8. Discuss the importance of national income statistics in an economy.
74
6 6
Meaning and importance of population
Population means the total number of people living in a particular
geographical area at a particular period of time. Such an area could
be a district, province or a country.
Population provides labour to an economy for the production of
goods and services. The supply of labour depends on the total number
of people in a country and the proportion of the total population
that can be engaged in productive employment. The productivity of
the country’s population will subsequently determine the national
income and standard of living.
Basic concepts in population
Fertility
Fertility refers to the ability of a woman to give birth to alive child.
It is inuenced by factors such as improved health, nutrition.
Growth rate
A change in the population size of a particular area over a given
period of time. The change can be positive or negative.
Specic objectives
By the end of this topic, the learner should be able to:
(a) Explain the basic concepts in population;
(b) Explain the implications of population size and
structure on the development of a country;
(c) Explain the meaning of employment and
unemployment;
(d) Discuss the various types and causes of unemployment;
(e) Discuss measures that may be taken to solve
unemployment problems.
Population and
Employment
75
Mortality rate
Thisisthenumberof deathsinagivenperiodinuencedbyfactorssuchaswar,adverse
climateconditionslikedrought,oods,andpopulation.
Over-population
A situation where the population of a country exceeds its available natural economic
resources.
Advantages of over-population
(a) Increased local market
Over-population increases the size of the home market for both manufactured and
agricultural products, leading to expansion of the sectors.
(b) Increased labour force
Over-population increases the supply of the labour force which can be utilised in
rural areas where land is readily available.
(c) Expansion of investment
Skilled labour force from the large population will boost investment through the
investment multiplier, leading to increased incomes and high consumption. High
consumption levels facilitate further investment.
(d) Promotes an energetic youthful population. The young population is available and
willing to work anywhere in the country and promote economic growth.
(e) Increase in innovation
Since there are limited employment opportunities in an over populated area, people
develop various ways of earning income, to improve their living standards.
Optimum population
Over-
population
Under-
population
Output per worker
Size of population
Fig. 6.2: Output per worker in relation to the size of population.
76
Disadvantages of over-population
(a) Encourages rural-urban migration
Rapid population increase, especially in rural areas, encourages rural urban migration
in search of job opportunities.
(b) Congested social amenities
Sudden population pressure will create problems in the existing amenities such as
sanitation, public parks, schools as well as health facilities. These facilities will not
meet the high demand of users hence poor social welfare delivery in urban areas.
(c) Poor living standards
Over-population leads to poor standards of living compounded by increased food
shortages. This leads to the emergence of slum areas.
(d) Imbalanced demand and supply forces
Over-population creates excess demand on domestic products and in such a situation
the demand is greater than supply. The prices will increase, causing continuous
increase in prices.
(e) Creation of unskillled labour
The country may not have adequate funds to facilitate educational institutions to
cope with increased demand. The available funds will be spent on providing food
which is essential for life.
Fig. 6.1: Development of slums is an indication of poor standards of living.
Under population
A situation where the country’s population is less than available natural economic
resources. Under population leads to the following disadvantages.
Disadvantage of under-population
(a) Untapped economic resources
The economic potential of the country may not be properly tapped due to inadequate
77
labour. Resources will lie idle.
(b) Limitations in specialization.
Due to a small number of the working population, people are forced to engage in
diverse economic activities which limits specialization.
(c) High cost of infrastructure.
Provision of transport and communication network is expensive in relation to expected
utilization of the facilities.
(d) Changes in provision of social amenities.
The small population may not adequately utilize social amenities which may have
cost a lot of money to put up.
(e) Lack of innovativeness and initiative.
Lack of resources utilization and low competition arising from a relatively small
innovativeness and initiative.
Optimum population
It is the size of population which is in balance with an available natural economic
resources.it is the ideal population that account desires for its resources.it is the
population at which existing technological knowledge, capital equipment is at its
maximum use and the population is experiencing full employment.
Migration
This refers to the movement of people from one region to another for settlement
purposes. This movement of people into a given region is known as immigration while
the movement of people out of a given region is known as emigration. The difference
between immigration and emigration is referred to as net migration.
Young population
This implies a population consisting of a large percentage of people who are under 5
years of age. This is a consumption population and draws the scarce resources away from
the needed investment; this retards the rate of economic growth.
Ageing population
This population consists of a large percentage of people aged 65 years and above. There
are problems associated with the trend of ageing population. Some of the problems
include:
(a) Oldpeoplearenotabletochangeandthereforenditdifculttoembracenewideas
such as information technology, as this may affect their productivity.
(b) Incountrieswheresocialwelfareisprovided,oldpeopleareregardedasanancial
burden to the government as they utilise social facilities without reciprocating in
productivity.
Population size refers to the number of people living in a particular geographical region.
On the other hand, Population structure is composition of population in terms of
characteristics such as age, sex, geographical distribution and income.
Implications of population size and structure on development
Rapid and slow population growth has been a hindrance on the economic growth of less
developed countries. The following are economic consequences of rapid and slow growth
in population on economic development.
78
(i) Decline in per capita income
Per capital income is national income per * calculated by dividing the national income
by total population. Low per capita income implies low pace of economic development.
While high per capita implies high rate of development.
(ii) High dependency ratio
High rate of population growth implies high levels of investment to achieve a given income
per capita. Young and ageing population increase consumption. Resources are diverted to
more consumption and less savings that can be translated into investment.
(iii) High unemployment rates
A rapid increasing population creates unemployment in a country. As population increases
the number of potential workers also increases. Population growth reduces income,
savings and investment. This retards capital formation and job opportunities reduce,
thereby increasing unemployment levels.
(iv) Encouragement of rural urban migration.
High population growth rate leads to a rapid growth in population put strain on available
economic resources. There by reducing economic development.
(v) Changes of provision of social infrastructure.
Rapid population growth calls for large investment in social infrastructure diverts resources
from capital investment.
(vi) Low capital formation
Population growth retards capital formation. As population increases, people are required
to feed more children with the declining per capita income. This reduces savings and
investment..
(vii) Low agricultural development.
The rapid population growth create pressure on land. This is caused by land fragmentation
limiting mechanization hence productivity.
(viii) Innovativeness and creativity
Slow growth populations lack innovativeness and creativity because of being content
withtheavailableresources.Theydonothavetoghtforsurvivalunlikethoseinrapidly
growing populations. This, hence, hinders development of a country.
(ix) Insufcient labour
Slow growing populations lack adequate labour to exploit all its resources. They sometimes
hire labour, thus increasing their expenditure which slows economic development.
Age structure pyramid
This is a graphical representation of the age-structure in a population.
Fig. 6.3 is a highly symmetrical pyramid representing the population structure in terms of
age and gender for development.
79
Over 70
60 - 69
50 - 59
40 - 49
30 - 39
20 - 29
10 - 19
0 - 9
Male
Female
Fig. 6.3: Hypothetical age and gender population structure.
Fromthegure,wecanseethatmostof thepopulationisstillyoung.Morethan90%of 
the population is between 0 and 59 years.
Most developing countries depict a broad base with a high percentage of a younger
population, most of whom are too young to be economically productive. It also shows
a small percentage of older people (60 years and over) and a modest numbers in the
middle group that is economically productive.
Implications of population structure on development
The age structure can be grouped into three categories namely;
a) Young children under 19 years
b) Middle age 20–59 years
c) Old age group over 60 years
Population structure has the following implications on economic development:
Employment and unemployment
Meaning of employment and unemployment
Employment is a situation where able vodied adult willing and able to *** is engaged in
productive activities of generating wealth and income.
Unemploymentis asituationwherewilling and ablebodied people cannotnf gainful
economic activities for them to be productive at the current wage rate.
Full employment
Full employment means a situation where every able-bodied adult is engaged in activity
for the required number of hours per week.
80
Problems of full employment
(i) Unstable government policies
Adoption of full employment policy creates pressure within the economy which may affect
the general policies on economic growth and development. A country which attempts to
attain full employment runs the danger of having too many people employed who are not
gainfully engaged.
(ii) Dangers of inflation
In a situation where there is full employment, this could resort to strong trade unions with
bargaining power. This could lead to high wage demand which in turn will result into high
ratesofination.
(iii) Unproportionate high demand
Full employment creates high consumption levels. This in turn creates demand which
may not be met by goods and services produced locally.
Types and causes of unemployment
Types of unemployment
There are various types of unemployment namely:
(i) Mass or cyclical unemployment
Mass unemployment arises due to a decline in aggregate demand for industrial products.
During depression the country experiences low purchasing power and people can hardly
afford to buy the goods produced. There is no investment and capital formation. When
investment cannot expand, then no employment opportunities are created. This situation
gives rise to widespread unemployment associated with trade cycles.
(ii) Structural unemployment
This is unemployment caused by a change in demand for goods and services. A shift in
demand for a certain good or service will directly affect the labour used in its production.
A general rise in income leads to change in tastes.
Introduction of new technology will create a new demand, leaving other commodities
obsolete. The labour used on the obsolete goods will be laid redundant, creating structural
unemployment. For instance, demand for plastic containers for packaging products led to
structural unemployment for workers in tin industries. Metal Box Company in Thika laid
off its work force due to lack of demand for tin products.
(iii) Seasonal unemployment
This type of unemployment arises because of the seasonal nature of a particular productive
activity. People become unemployed during the low season i.e. tourists visit different sites
during particular seasons. During off season people become unemployed.
(iv) Casual or frictional unemployment
Thistypeiscommonwithcasualworkers,whodonothavespecicskillsandareemployed
on temporary basis. The workers lose their jobs when the contracts between them and the
employers end as soon as the work is over.
81
(v) Technological unemployment
The increased use of modern machines, which are automated, has reduced the demand
for labour. If capital-intensive methods of production are preferred to labour-intensive
methods, some workers will lose their jobs. For example, the use of Automatic Teller
Machines(ATM)inbanksandothernancialinstitutionshasreducedtheneedfortellers,
leading to the laying off of workers.
Fig. 6.4: Use of ATM machines has reduced the need for tellers in banks.
(vi) Residual unemployment
This type of unemployment arises due to the inability to work due to disability. Such
disabilities arise from mental or physical disorders.
(vii) Disguised unemployment
This type of unemployment occurs when some people appear to be employed while
the nature of work they do and the level of income make them virtually unemployed.
Disguised employed labour force can be withdrawn without causing any change in the
output.
(viii) Urban unemployment
This occurs due to the difference in incomes between urban and rural workers. This wage
difference causes rural-urban migration leading to unemployment in towns.
Causes of unemployment
Kenya experiences all types of unemployment discussed above. In addition, it experiences
under-employment.Under-employmentisdenedasthelackof accesstoincome-earning
opportunities. This implies many people are employed but their productivity and income
are unacceptably low. The causes of unemployment and under-employment in Kenya
include:
(i) Rapid population growth
High population growth disproportionate to capital investment rate leads to an increase in
the number of people who are not employed.
82
(ii) Low economic growth
The low growth rate of the economy does not stimulate enough employment opportunities
to absorb all the job-seekers.
(iii) Job selection
Most school leavers who constitute a large proportion of the unemployed tend to prefer
white-collar jobs and believe that the jua kali jobs are unsuitable for them. They remain
unemployed as they look for white collar jobs.
(iv) Seasonality of jobs
Sometimes, unemployment is caused by the seasonal nature of some jobs. For instance,
in the tourism sector, job opportunities depend on the season. During high peak seasons,
more jobs are available, while during the low season (fewer tourists), some people lose
their jobs. Coffee harvesting is a seasonal activity. Workers are laid off during the off-peak
season.
(v) Technological applications
The adoption of modern technologies in the industrial sector has resulted in people
being laid off. For example, banks using automated teller machines and computers. The
telecommunications industry had to lay off workers due to technological changes such
as introduction of internet and mobile phone services.
(vi) Poor planning and mismanagement
Misuse of public funds has led to collapse of enterprises leading to unemployment.
Solving unemployment problems
ThespecicmeasuresthatmaybetakentocontrolunemploymentinKenyainclude:
(i) Managing population growth
The rapid population growth has caused an increase in labour force that the economy
cannot absorb. The population structure has more young people below the age of 16 years
who are unproductive. If the growth rate could be reduced, then the government would
have funds for capital investment to create job opportunities.
Fig. 6.5: Enhancement of Jua Kali can solve the problem of unemployment.
83
(ii) Diversification of agricultural and industrial activities
Investment in agriculture, industry and trade would boost job creation. The informal
sector (jua kali), tourism, building and construction sub-sectors of the economy can be
enhanced to supplement the agricultural and industrial sectors.
(iii) Providing relevant education
Relevant education and training opportunities will ensure that people have the necessary
skills. Appropriate education policies should therefore be formulated to equip the population
with appropriate knowledge, skills and attitudes and take up employment opportunities.
(iv) Provision of social amenities in rural areas
Lack of social amenities in rural areas contributes to rural-urban migration. To contain
this situation, it is necessary for social amenities to be established in rural areas.
(v) Delocalisation to contain rural urban migration
Industries should be established in rural areas to proportionate job opportunities.
Delocalisation can be achieved through provision of incentives to investors to invest in
rural areas. Such incentives include tax concessions and provision of infrastructure. This
willreducetheurbanunemploymentduetothereducedrural-urbaninuxandreduced
imbalance in development.
(vi) Use of labour-intensive techniques
Large scale farming that adapt labour intensive operations should be encouraged. The use
of tractors, combine harvesters will increase large tracks of land to be cultivated. This
will create jobs in clearing the new land, mechanics to maintain the machines, drivers and
machine operators. Large scale agriculture require comprehensive researches on better
seeds for different seasons and variety. This will ensure jobs throughout the year and more
jobs for research personnel. However, advanced training is required and mechanization
introduced gradually so that no employee is laid off because of obsolete skills.
Exercise 6.1
1. Explain the meaning of the term population.
2. Explainthesocialandeconomicfactorsthatinuencethefertilityrateinacountry.
3. Explain each of the following terms:
(i) Young and Ageing Population
(ii) Over-population and under-population
(iii) Declining population distribution
(iv) Population growth rates
4. Given that the number of births and deaths per thousand people in your location
are 50 and 40 respectively, calculate the natural population growth rate in your
location.
5. Explain the effect of a declining population in a country.
6. Explain the implications of a population structure and size on the economic
development of a country.
84
Exercise 6.2
1. Differentiate between unemployment and employment.
2. GivevecausesofunemploymentinKenya.
3. Explain the main types of unemployment.
4. Explain the measures that the Kenyan Government has taken to reduce
unemployment.
Revision Questions
1. Deneeachofthefollowingterms:
(i) Mortality rate
(ii) Population
(iii) Full employment
(iv) Unemployment
2. Explainthemeaningof‘populationstructure’.
3. Explainveadvantagesofover-population.
4. Explain the effect of population size on development of a country.
5. Explain the problems of full employment in an economy.
6. Discuss the various types of unemployment.
85
7 7
Introduction
In Form I Business Studies, we dened business as the provision
of goods and services for prot or gain. Business involves the
selling of goods or services with the aim of making prot. It is
therefore important for the owner of the business to be able to
determine whether the business is making prot or not.
We also learnt that Business Studies involves the acquisition
of knowledge, skills and positive aitudes that enable a business
owner to succeed in business. One aspect of such knowledge
involves the ability of the business person to keep proper and
accurate nancial records of the business, and use the same records
to determine the prot or loss made by the business. These records
would also enable us to determine the value of the business to its
owner. This is known as the net worth of the business.
Specic objectives
By the end of this topic, the learner should be able to:
(a) Explain the meaning of the terms assets, liabilities
and capital;
(b) Derive the book-keeping equation;
(c) Prepare a simple balance sheet;
(d) Relate the accounting equation to the balance sheet;
(e) Explain the meaning of net worth of a business.
Net Worth of a
Business
86
Maintaining nancial records is known as book-keeping. Besides providing the
information used to calculate prot or loss, these records also provide information on:
(i) the amount of money invested in the business.
(ii) the amount of money spent in buying goods or providing services.
(iii) the amount of money earned by the business through its business activities.
(iv) the amount of money spent by the business on other services required by the
business i.e. its expenses.
(v) the amount of money owed to the business.
(vi) the amount of money owed by the business.
(vii) the value of all property owned by the business.
(viii) the value of the business to its owner.
Itisfromsuchinformationthatoneisabletoevaluatewhethertheprotmadebythe
business is worth the effort and resources invested in the business.
Meaning of assets, liabilities and capital
Earlier on, we also learnt that it is important for the owner of a business to distinguish
between the business and himself or herself. The business must be treated as a ‘person’
separate from its owner. Most business people do that by giving the business a name
to distinguish it as a separate entity. This is important because business records must
be distinctly kept separate from the owner’s personal records. Such business records
will reveal the value of assets, liabilities and capital of the business.
Assets
Property owned by a business.
Assets are classied into two major categories, namely
(i) Fixed assets
(ii) Current assets.
Fixed assets
These are physical tangible properties owned and used by the business in its productive
activities. They are not acquired for resale. They are normally permanent in nature.
Examples include buildings, furniture, equipment, motor vehicles, oce machines,
xtures and ings.
(ii) Current assets
Property owned by a business for a short period of time
These mainly consist of properties purchased for the purpose of resale, or use in the
business over a short period of time. Examples include goods in the business for resale
(known as stock), debtors, cash at the bank and cash in hand. The photograph below
shows stock for sale in a business. Stock is an example of current assets.
Liabilities
What business owes to outsiders they represent what business has to pay other parties
Liabilities are also classied into two major categories, namely:
(i) Long term liabilities
(ii) Current liabilities.
87
Long Term Liabilities
These are debts owed by the business to other people or organisations and are payable
over a long period of time, usually more than a year. Examples of such debts include
loans borrowed by the business from other organisations such as banks. Such long
term liabilities are usually paid over along period of time with interest.
Current Liabilities
These are debts owed by the business and are payable within or over a short period of
Fig. 7.2: Stock in a shop; it is a current asset.
time, usually within one year. They are also known as short term liabilities.
Examples include: Bank overdrafts, creditors, outstanding expenses.
Capital
Capital refers to the claim of the owner of the business over the business. Such claim
consists of all the resources contributed by the owner of the business (either in cash or
other assets) as well as all the prots made by the business.
The book-keeping equation
A mathematical relationship between assets of business, capital and liability.
It is also known as the accounting equation. The book-keeping equation is derived
from the fact that all the resources of a business i.e. the assets should be equal to the
total sum of the funds or money contributed by the owner (capital) and the creditors
(liabilities). This can be expressed as:
Assets = Capital + Liabilities
A = C + L
Capital = Assets – Liabilities
C = A - L
88
Example:
The following information was contained* from nancial records of a trader
on 1st January 2017:
Ksh.
Stock of goods for sale 50,000
Bicycle 5,000
Amount owing to the supplier 30,000
Cash in the shop 5,000
Cash at the bank 35,000
Amount borrowed from a Sacco 20,000
To calculate the capital of the business from the information above, Mwerevu
would have to follow the following steps:
(i) Determine the total value of the assets:
ASSETS Ksh.
Stock of goods for sale 50,000
Bicycle 5,000
Cash in the shop 5,000
Cash at the bank 35,000
Total assets 95,000
(ii) Determine the total value of the liabilities:
LIABILITIES Ksh.
Amount owing to the supplier 30,000
Amount borrowed from a Sacco 20,000
Total liabilities 50,000
(iii) Determine the capital using the formula:
Capital = Assets – Liabilities
= Sh. 95,000 – Sh. 50,000
= Sh. 45,000
The Capital is therefore Sh. 45,000
89
Exercise 7.1
1. Calculate the capital of the business in each of the following cases.
Ksh.
(a) Cash in hand 2,400
Debt due to Odhiambo 27,600
Debt due from Achando 12,000
Stock of goods 28,000
(b) Assets and Liabilities: Ksh.
Bank loan 53,000
Cash in hand 5,000
Debt due for goods bought on credit 27,600
Debt due from a customer 15,000
Stock of goods 28,000
Shop furniture 25,000
Value of kiosk building 70,000
(c) Assets and Liabilities: Ksh.
Stock of goods 120,000
Debtors 40,000
Creditors 50,000
Machinery 150,000
Furniture and ings 25,000
Cash in hand 15,000
2. Copy the table given below and ll in the blank spaces appropriately.
CAPITAL LIABILITIES ASSETS
Ksh. Ksh. Ksh.
(a) 157,000 86,500
(b) 247,000 885,000
(c) 273,000 300,000
(d) 20,500 17,620
(e) 46,900 62,600
90
The Balance sheet
The most important information one would want to know about a business is the
nancial position or condition of its assets, liabilities and capital. This is important
because it reveals alot of information about the business such as:
(i) the amount of money invested by the business owner.
(ii) the amount of money owed by the business to other people and organisations.
(iii) the amount of money owed to the business by other people and organisations.
(iv) the nancial status of the business.
(v) the amount of money the owner claims over the business i.e. net worth of the
business to its owner.
Every business should have records showing this information. In a business where
such records do not exist, the information can be determined by preparing a statement
showing a summarised list of:
a) all the assets of the business and their values.
b) all the liabilities of the business and their values.
c) the capital of the business.
In book-keeping, this information is prepared in a special format known as a balance
sheet.
A balance sheet has two columns as shown below. One side is used to list all the
assets and their values, while the other side is used to list all the liabilities and the
capital. The example given below shows the balance sheet of Uchumi Provision Store,
Mwerevu’s family business.
UCHUMI PROVISION STORE
BALANCE SHEET
From the above balance sheet, it will be noted that:
• Capital and Liabilities are on the same side. This is because capital is also a liability
of the business to the owner as we have already learnt earlier. In most cases, this
side is simply referred to as the liabilities side.
• Both sides of the balance sheet have equal totals. The two sides are said to be in
balance, hence the name balance sheet.
• The totals of the balance sheet are wrien on the same horizontal line.
• The ruling of the total has a single line above the total and a double line below
the total.
ASSETS CAPITAL AND LIABILITIES
KSh. KSh.
Bicycle 5,000 Capital 45,000
Stock of goods 50,000 Loan from
Cash at the bank 35,000 Sacco 20,000
Cash in the shop 5,000 Debt owing to a supplier 30,000
95,000 95,000
91
A balance sheet can thus be likened to the two sides of a weighing scale balance. It
must always balance as illustrated in the diagram below.
Every time a nancial business activity takes place, the value of certain items on the
balance sheet will change. The values may increase or decrease. The items aected will
be two or more. However, after the values of the items aected have been adjusted
accordingly, the totals of the balance sheets must still remain in balance. Everyday,
nancial activities will take place resulting to changes in the values of various items on
the balance sheet. Thus, the balance sheet prepared on one day will be quite dierent
from the balance sheet prepared at the end of the next day. When preparing the balance
sheet, it is therefore important to state the following information:
• The name of the business
• The name or title of the statement i.e. Balance sheet
• The date at which it is prepared.
Based on the information learnt above, the balance sheet of Uchumi Provision Store
would now appear as follows:
ASSETS
Ksh. 95,000
BALANCE • SHEET
CAPITAL
Ksh. 45,000
LIABILITIES
Ksh. 50,000
UCHUMI PROVISION STORE
BALANCE SHEET
AS AT 5
TH
DECEMBER, 2015
ASSETS CAPITAL AND LIABILITIES
Ksh. Ksh
Bicycle 5,000 Capital 45,000
Stock of goods 50,000 Loan from
Cash at the bank 35,000 Sacco 20,000
Cash in the shop 5,000 Debt owing to a supplier 30,000
95,000 95,000
Relationship between book-keeping equation and Balance
sheet
The book-keeping equation and the Balance sheet are very closely related.
As regards the book-keeping equation, we have learnt that, whenever a nancial
activity takes place in a business, it results to changes in the values of certain assets,
liabilities or capital. After the resulting changes in values of the assets liabilities or
92
capital aected have been eected, the total assets will still equal the total of the
liabilities and capital as expressed below.
Assets = Liabilities + Capital
A = L + C
On the other hand, we have also seen that whenever a balance sheet is prepared the
total assets on the assets side must equal the total of the capital and the liabilities on
the liabilities side as shown below.
Assets side = (Capital + Liabilities) on liabilities side
A = C + L
Consequently, the book keeping equation can also be referred to as the balance sheet
equation.
Net worth of a business
This refers to the monetary value of a business; to its owner. It is what is reered to
as capital. In other words, it is the nancial value of a business to its owner. It is also
described as the worth of the business to its owner.
It is the claim of the owner of a business over the business. There are two parties
that have a claim over a business; the owner of the business and other people or
organisations whom the business owes money. The balance sheet equation can also
be expressed as:
Assets = Owner’s claim + Claims by other parties
While the owner’s claim over the business is known as Net worth, the claims by
other parties over the business is referred to as liabilities. The balance sheet equation
therefore is also expressed as:
Assets = Net worth + Liabilities
Importance of a balance sheet
A balance sheet is very important and essential to a business. It provides very useful
information used to make very important decisions about the business. For example:
(i) The managers of the business use information provided by the balance sheet to
evaluate the performance of the business and make management decisions about
the business.
(ii) The owner of the business uses the information provided by the balance sheet to
evaluate and determine whether the business is worth the investment made.
(iii) The government uses the information provided by the balance sheet to evaluate
and determine the amount of tax to charge the business.
(iv) Financial institutions such as banks and other organisations which lend money
to businesses use the information provided by the balance sheet to evaluate the
nancial position of the business and determine whether it is safe to lend money
to the business or not and how much to lend.
(v) Other investors who may be interested or wish to invest in the business use the
information provided by the balance sheet to evaluate and determine whether to
invest in the business or not.
93
BARAKA PROVISION STORE
BALANCE SHEET
AS AT 31
ST
DECEMBER, 2015
ASSETS
Ksh. Ksh.
Fixed Assets:
Shop Building 850,000
Furniture 25,000
Motor Vehicle 190,000
1,065,000
Current Assets:
Stock 250,000
Debtors 90,000
Cash in hand 5,000
345,000
1,410,000
LIABILITIES
Ksh. Ksh.
Capital 500,000
Long term liabilities:
Bank loan(5yr) 300,000
Sacco
loan(3yr) 200,000
500,000
Current Liabilities
Creditors 250,000
Bank Overdraft 160,000
410,000
1,410,000
Balance sheet presented in order of permanence
(vi) The suppliers of goods and services to the business also use the information
provided by the balance sheet to evaluate and determine whether the business
is credit worthy or not, whether the business can be allowed credit, the amount
of credit it can be allowed and the conditions under which the business can be
allowed credit.
Style of presentation of a balance sheet
There are two styles of presenting a balance sheet, namely; the order of
permanence and the order of liquidity.
Order of permanence
With this style of presentation, assets on the balance sheet are arranged, starting with
the most permanent asset and ending with least permamnent.
The order ends with the asset that is least permanent i.e. the asset with the shortest
life in the business. The list of the assets under both categories i.e. starting from xed
assets and ending with current asset on one hand, on the other side starting with
capital, long term liabilities and ending with current liabilities.
In this book, we have also adopted this order for most balance sheets.
The balance sheet given below illustrates this.
Order of liquidity
Assets are arranged starting with current assets, ending with xed assets. The
liabilities are arranged starting with the current liabilities and ending with capital. An
example is given below.
94
BARAKA PROVISION STORE
BALANCE SHEET
AS AT 31
st
DECEMBER, 2015
ASSETS
Ksh. Ksh.
Current Assets
Cash in hand 5,000
Debtors 90,000
Stock 250,000
345,000
Fixed Assets:
Motor vehicle 190,000
Furniture 25,000
Shop Building 850,000
1,065,000
1,410,000
LIABILITIES
Ksh. Ksh.
Current Liabilities:
Bank Overdraft 160,000
Creditors 250,000
410,000
Long term Liabilities:
Co-operative Loan
(3 yrs) 200,000
Bank Loan
(5 yrs) 300,000
500,000
Capital 500,000
1,410,000
95
BARAKA PROVISION STORE
BALANCE SHEET AS AT
31
ST
DECEMBER, 2015
ASSETS
Ksh. Ksh.
Fixed Assets
Shop building 850,000
Furniture 25,000
Motor Vehicle 190,000
1,065,000
Current Assets
Stock 250,000
Debtors 90,000
Cash in hand 5,000
345,000
1,410,000
LIABILITIES
Capital 500,000
Long Term Liabilities
Bank Loan (5 years) 300,000
Sacco Loan (3 years) 200,000
500,000
Current Liabilities
Creditors 250,000
Bank Overdraft 160,000
410,000
1,410,000
96
Exercise 7.4
When drawing up the balance sheet in each of the exercises given below, classify
the assets and liabilities into xed assets, current assets, capital, long term liabilities
and current liabilities appropriately. Indicate the sub-totals in each case and prepare
the balance sheet in order of permanence except where specied.
1. Draw up the balance sheet of Odero Enterprise as at 31
st
July, 2015 from the
following information.
Ksh.
Trade creditors 37,500
Other creditors 3,705
Furniture 23,000
Business premises 200,000
Ksh.
Stock of goods 50,060
Trade debtors 12,000
Cash at bank 9,800
Loan from L. Awinja 50,000
Cash in hand 2,500
2. Prepare the balance sheet of Fruit Paradise Kiosk according to the order of
liquidity. The business had the following assets and liabilities as at 30
th
April,
2016:
Cash in hand Sh. 3,125; Stock of goods Sh. 23,460; Equipment Sh. 5,690.
Customers owed the business money as follows:
J.C. Makau Sh. 485, W. Noel Sh. 660 and T. Abdi Sh. 110.
The business owed its suppliers money as follows:
White and Son Distributors Sh. 1,975; and Brown Manufacturers Sh. 1,216.
Cash at bank Sh. 10,500.
3. Donald Grocers had the following assets and liabilities as at 31
st
May, 2016.
Cash at Bank Sh. 11,800; Stock for sale Sh. 43,200; Cash in hand Sh. 1,650, Customers
owed the business money as follows:
L. Salima Sh. 1,520 and T.Charo Sh. 2,460. Delivery equipment Sh. 22,500, Machinery
Sh. 28,300; and Buildings Sh. 35,000.
The liabilities of the business consisted of:
Baraka Distributors Sh. 3,550 and Copper Wholesalers Sh. 2,480. Bank Loan
Sh. 10,000.
Required:
Prepare the balance sheet of the business as at 31
st
May, 2016 using the vertical
format.
97
Case Study
In an eort to promote investment and improve the management of small scale
businesses, the government has appointed Regional Trade Ocers throughout the
country. Each trade ocer is responsible for carrying out activities within the region
he or she is responsible to ensure that small scale businesses within the region are well
managed and successful. Such activities include organising the owners of small scale
businesses into business associations and train them in basic business management
principles, skills and practices.
One of the trade ocers has successfully organised a group of small scale retailers
into such an association. After interacting with them for a while, she has found out
that there is lack of knowledge in basic business concepts and skills and there is no
keeping of proper business records. She has planned, as a rst step, to teach them the
concept of the balance sheet as the most basic business record and its importance to
the success of a business.
(a) Explain why it is important for every business to keep proper and accurate
business records.
(b) Explain why the balance sheet should be the rst concept that the traders would
need to understand.
(c) Explain the information about a business that is revealed by the balance sheet.
(d) Describe the procedure that each of the traders in the stated business association
should follow in drawing up the rst balance sheet of his or her business.
Practical Activity
1.Your teacher may divide the class into three teams A, B and C. Each team will also
be sub-divided into groups of not more than three members each. Each team will be
assigned activities as follows:
Team A: Each group in the team should visit at least one small scale business such as
a small kiosk, a roadside seller or market seller.
Team B: Each group in the team should visit at least one well stocked shop or a busy
business such a a hotel, hair saloon or a local busy shop.
Team C: Each group should visit a large scale business such as a supermarket, self
service store or a busy hotel.
During the visit, each group should nd out and record the following information:
(i) The name of the business or the owner of the business.
(ii) List all the assets of the business and their estimated values.
(iii) List all the liabilities of the business and their estimated values.
This information should be recorded in a table similar to the one given below.
ASSETS
LIABILITIES
NAME OF
ASSET
NAME OF
LIABILITY
VALUE
(Kshs.)
VALUE
(Kshs.)
NAME OF
BUSINESS
98
LIABILITIES
(SOURCE OF FUNDS)
OTHER
LIABILITIES
(Ksh.)
NAME OF
BUSINESS
ASSETS
(USES OF FUNDS)
CAPITAL
(Ksh.)
FIXED
ASSETS
(Ksh.)
CURRENT
ASSETS
(Ksh.)
After collecting and recording the information:
(a) Each group should prepare a balance sheet for each business visited.
(b) Each team should meet and compile a report about the categories of the business
visited by the groups in the team showing:
(i) The name of the business.
(ii) The amount of capital invested in the business by the owners.
(iii) The total value of the liabilities.
(iv) The amount of funds invested in xed assets.
(v) The amount of funds invested in current assets.
A table similar to the one given below should be used.
Revision Questions
1. State one difference between assets and liabilities.
2. Highlighttwodifferencesbetweenxedassetsandcurrentassets.
3. Explain why capital is considered as a liability in a business.
4. Highlight the ways in which the balance sheet of a business would be useful.
5. Study the balance sheet below and answer the question that follows.
99
VYEMA ENTERPRISES
BALANCE SHEET, AS AT 30
TH
MAY 2016
Sh. Sh.
Capital 100,000
Current Liabilities:
3 Year bank loan 30,000
Cash at bank 15,000
Cash in hand 5,000
50,000
Long term Liabilities:
Creditors 11,000
Furniture 40,000
51,000
201,000
Fixed Assets
Buildings 50,000
Stock 25,000
Debtors 16,000
91,000
Current Assets:
Premises 50,000
10 year mortgage loan 50,000
Expense creditors 10,000
110,000
201,000
Re-draft the balance sheet according to the order of permanence correcting all
the errors made.
6. The following are assets and liabilities of Gatanga Furniture Shop as at 1
st
May, 2015.
Ksh.
Furniture for sale 100,000
Cash at Bank 55,000
Cash in hand 6,000
Furniture, not for sale 25,000
Creditors 50,000
Unpaid electricity bill 5,000
Money borrowed 31,000
Prepare the balance sheet of the shop according to the order of liquidity.
100
7. The balance sheet of Vijana Choice Shop is given below:
The following activities took place in the business between 1
st
July, 2016 and 5
th
July, 2016:
(i) The proprietor deposited Sh. 70,000 into the business bank account which
he had won from a sweepstake competition.
(ii) All the trade creditors were paid in full by cheque.
(iii) A debtor paid in cash Sh. 10,000.
(iv) The amount owing to the expense creditors were paid by cheque.
(a) For each of the activities (i) to (iv) above, explain how the balance sheet
was aected.
(b) Draw up the balance sheet of the business as at 5
th
July, 2016.
8 Explain why the two sides of a balance sheet must always balance.
LIABILITIES
Ksh. Ksh.
Capital 120,000
Current Liabilities:
Trade creditors 60,000
Expense creditors: 2,000
62,000
182,000
ASSETS
Ksh. Ksh.
Fixed Assets:
Premises 40,000
Motor vehicle 80,000
120,000
Current Assets:
Stock 30,000
Debtors 20,000
Cash at bank 10,000
Cash in hand 2,000
62,000
182,000
VIJANA CHOICE SHOP
BALANCE SHEET
AS AT 30
TH
JUNE 2009
101
8 8
Meaning of a business transaction
Exchange of goods and services between two parties for a
consideration
Cash and credit transactions
Cash transactions
A cash transaction is a where goods or services are exchanged for
money and paid on the spot.
Credit transactions
A credit transaction is a business activity where goods or services
change hands from a seller to a buyer, but payment is made at a
later date.
Effects of transactions on the balance sheet
(i) Contribution of assets by the owner to start business
Baraka started a business with Sh. 50,000 in cash on 2nd
January 2016.
Specic objectives
By the end of this topic, the learner should be able to:
(a) Explain the meaning of a business transaction;
(b) Distinguish between cash and credit transactions;
(c) Determine the effect of transactions on the balance sheet;
(d) Discuss causes of changes in capital;
(e) Determinetheinitialandnalcapitalof abusiness.
Business
Transactions
102
(ii) Purchase of an asset in cash
On 3
rd
January, 2016 Baraka Enterprises bought furniture for Sh. 15,000 and paid
cash. After this transaction, the balance sheet of his business will appear as follows:
BARAKA ENTERPRISES
BALANCE SHEET
AS AT 3
RD
JANUARY, 2016
ASSETS LIABILITIES
Ksh.
Furniture 15,000
Cash 35,000
50,000
Ksh.
Capital 50,000
50,000
Eect of this transaction on the balance sheet:
It will be noted that a new asset, furniture, Sh. 15,000 has come on the balance sheet,
while the asset, cash has decreased by Sh. 15,000 to Sh. 35,000. We can therefore
conclude that the eect of this transaction is to:
• Increase the asset, furniture by Sh. 15,000.
• Decrease the asset, cash by Sh. 15,000.
(iii) Purchase of an asset on credit
On 4
th
January, 2016, Baraka Enterprises bought weighing equipment from
Weights and Measures Ltd. on credit at Sh. 25,000. The balance sheet of his business
as at 4
th
January 2016 after this transactions will appear as follows:
BARAKA ENTERPRISES
BALANCE SHEET
AS AT 2
ND
JANUARY, 2016
LIABILITIES Ksh.
Capital 50,000
50,000
ASSETS Ksh.
Cash 50,000
50,000
103
Eect of this transaction on the balance sheet:
A new asset, equipment worth Sh. 25,000 has come on the balance sheet. Likewise,
a new liability-creditors; Weights and Measures Ltd. Sh. 25,000 has also come on the
balance sheet. We can conclude that the eect of this transaction on the balance sheet
is to:
• Increase the asset, equipment by Sh. 25,000.
• Increase the liability creditors, Weights and Measures Ltd. by Sh. 25,000.
(iv) Payment of a debt owed by the business
On 5
th
January, 2016, the creditor, Weights and Measures was paid Sh. 15,000 in
cash as a part payment of the debt. After this transaction, the balance sheet of the
business as at 5
th
January 2016 will appear as follows:
BARAKA ENTERPRISES
BALANCE SHEET
AS AT 5
TH
JANUARY, 2016
ASSETS LIABILITIES
Ksh.
Furniture 15,000
Equipment 25,000
Cash 20,000
60,000
Ksh.
Capital 50,000
Creditors
(Weights and
Measures Ltd) 10,000
60,000
BARAKA ENTERPRISES
BALANCE SHEET
AS AT 4
TH
JANUARY, 2016
ASSETS LIABILITIES
Ksh.
Capital 50,000
Creditors
(Weights and
Measures Ltd) 25,000
75,000
Ksh.
Furniture 15,000
Equipment 25,000
Cash 35,000
75,000
Eect of this transaction on the balance sheet:
It will be noted that the result of this transaction has been to decrease the asset, cash by
Sh. 15,000, while at the same time decreasing the liability creditors, Weights and Measures
Ltd. by Sh. 15,000. Thus, we can conclude that the eect of this transaction is to:
104
It will be noted that, the eect of this transaction has been to decrease the asset, furniture,
by Sh. 5,000 and to increase the asset, cash, by Sh. 5,000. We can thus conclude that the
eect of this transaction is to:
• Decrease the asset furniture by Sh. 5,000.
• Increase the asset, cash by Sh. 5,000.
(vi) Sale of an asset on credit
On 8
th
January, 2016, Baraka Enterprises sold some of the equipment on credit to
another business known as Mukoya Investments for Sh. 8,000. This is the price
they had been bought for earlier. After this transaction, the balance sheet as at 8
th
January 2016 will appear as follows:
Eect of this transaction on the balance sheet:
• Decrease the asset, cash, by Sh. 15,000.
• Decrease the liability, creditors, Weights and Measures Ltd. by Sh. 15,000.
(v) Sale of an asset for cash
On 6
th
January, 2016, some of the furniture was sold for cash at the price they
had been bought for earlier of Sh. 5,000. The balance sheet of the business as at
6
th
January 2016 will appear as follows after this transaction:
Eect of this transaction on the balance sheet:
BARAKA ENTERPRISES
BALANCE SHEET
AS AT 6
TH
JANUARY, 2016
ASSETS LIABILITIES
Ksh.
Capital 50,000
Creditors (Weights and 10,000
Measures Ltd)
60,000
Ksh.
Furniture 10,000
Equipment 25,000
Cash 25,000
60,000
BARAKA ENTERPRISES
BALANCE SHEET
AS AT 5
TH
JANUARY, 2016
ASSETS LIABILITIES
Ksh.
Furniture 15,000
Equipment 25,000
Cash 20,000
60,000
Ksh.
Capital 50,000 Creditors
(Weights and
Measures Ltd) 10,000
60,000
105
It will be noted that the eect of this transaction has been to decrease the asset,
equipments by Sh. 8,000 and increase another asset, debtors, Mukoya Investments by
Sh. 8,000.
Thus the eect of this transaction on the balance sheet is to:
• Decrease the asset, equipment, by Sh. 8,000.
• Increase the asset, debtors, Mukoya Investment by Sh. 8,000.
(vii) Receipt of money by the business in payment of a debt
On 9
th
January, 2016, Mukoya Investments paid Sh. 5,000 in cash as part payment
of their debt. After this transaction, the balance sheet of the business as at 9
th
January , 2016 will appear as follows:
Eect of this transaction on the balance sheet:
It will be noted that the eect of this transaction is to decrease the asset, debtors
Mukoya Investments by Sh. 5,000 and increase the asset, cash, by Sh. 5,000. Thus the
eect of this transaction can be summarised as:
• Decrease in asset debtors, Mukoya Investments by Sh. 5,000.
• Increase in asset, cash, by Sh. 5,000.
(viii) Contribution of additional assets into the business by the owner from personal
sources.
On 10
th
January, 2016, Baraka decided to surrender his personal motor vehicle
worth Sh. 250,000 to the business. The balance sheet of the business as at 10
th
January, 2016 after this transaction will appear as follows:
BARAKA ENTERPRISES
BALANCE SHEET
AS AT 9
TH
JANUARY, 2016
Ksh.
Capital 50,000
Creditors (Weights and
Measures Ltd) 10,000
60,000
Ksh.
Furniture 10,000
Equipment 17,000
Debtors
(Mukoya Investments) 3,000
Cash 30,000
60,000
ASSETS LIABILITIES
106
Exercise 8.1
1. (a) Draw a new balance sheet of Kamaru Retail Shop at the end of each of the
following transactions that took place in May, 2016.
May 1 J. Kamaru started the business by contributing Sh. 100,000 which he deposited
in a bank account for the business.
May 3 The business bought equipment for Sh. 40,000 and paid by cheque.
May 4 The business purchased oce furniture for Sh. 20,000 on credit from Classic
Furniture Makers.
May 5 The business sold part of the equipment at its cost price of Sh. 10,000 on
credit to J. Omolo.
May 6 The business sold part of the oce furniture for cash Sh. 2,500.
May 10 The business paid Classic Furniture Makers Sh. 15,000 by cheque.
May 15 Received Sh. 8,000 in cash from J. Omolo in part payment of his debt.
(b) State the eect of each of the transactions in 1(a) above using the format given
below.
Eect of this transaction on the balance sheet:
It will be noted that the eect of this transaction is to increase the asset, motor vehicle,
by Sh. 250,000 and also increase the liability capital by Sh. 250,000. Thus the eect of
this transaction on the balance sheet is to:
• Increase asset, motor vehicle, by sh. 250,000.
• Increase liability, capital, by Sh. 250,000.
BARAKA ENTERPRISES
BALANCE SHEET
AS AT 10
TH
JANUARY, 2016
Ksh.
Capital 300,000
Creditors
(Weights and
Measures Ltd) 10,000
310,000
Ksh.
Furniture 10,000
Equipment 17,000
Motor vehicle 250,000
Debtors
(Mukoya Investments ) 3,000
Cash 30,000
310,000
ASSETS LIABILITIES
107
Example
DATE OF
TRANSACTION
EFFECT ON BALANCE SHEET
AMOUNT
Ksh.
May 1
(i) Increase in assets, cash at bank
(ii) Increase in liability, capital
May 3
100,000
100,000
May 4
May 5
May 6
May 10
May 15
2. State the eect of each of the following transactions on the balance sheet of a
business identifying the specic asset or liability aected and the amount.
(a) Bought shop ings for sh. 15,000 in cash.
(b) Sold a motor vehicle belonging to the business on credit to Western
Motors for Sh. 300,000.
(c) Received a cheque for Sh. 55, 521 from a debtor, Marion Boutique.
(d) The proprietor deposited Sh. 50,000 by cheque from her personal earnings
into the business account.
(e) Sold part of the oce furniture for Sh. 30,000 in cash.
3. Jane Kwamboka started her business on 1
st
March, 2016 with Sh. 100,000 in
a business bank account. During the rst week of business, the following
transactions took place:
(a) She bought a kiosk for Sh. 75,000 and paid by cheque.
(b) Bought shop ings on credit from Meko Casements for Sh. 25,000.
(c) Withdrew Sh. 10,000 from the business bank account for use in the kiosk.
(d) Bought shop furniture for Sh.8,000 which she paid in cash.
(e) Sold some of the shop ings to a friend, Sussy, on credit at their cost
value of Sh. 5,000.
Required:
(i) State the eect of each of the above transactions on the balance sheet.
(ii) Prepare the balance sheet of the business as at 8
th
March, 2016.
108
Causes of changes in capital
Capital can be described as the owner’s share of the business. It has been described
as the liability of the business to its owner or the net worth of the business to its owner
or the owner’s equity. Just as various transactions aect the assets and liabilities
of a business, the capital is also aected. Some transactions result in a reduction or
decrease in the capital, while other transactions result to in an increase in the capital.
Some examples of such transactions are given below.
(a) Transactions that result to increase in capital
Various transactions give rise to an increase in the capital of a business. These
include the following:
1. Additional investment
For most businesses, the rst transaction that takes place usually involves the
contribution of capital by the owner of the business. Capital may be contributed
in the form of cash or assets such as furniture, motor vehicles and equipment.
Capital contributed at the start of business is referred to as initial capital or initial
investment. Thus initial investment in a business may be in form of cash or in
equipment. Further or additional investments in the business may also be made
in cash or equipment by the owner of the business. Such additional investments
increase the capital.
Example:
Mary Nabwera started a hair salon business on 2
nd
May, 2015 by contributing
Sh. 100,000 which she deposited in a bank account for the business and some
furniture from her house worth Sh. 30,000. The balance sheet of her business as
at 2
nd
May, 2015 would appear as follows:
On 3
rd
May, 2015, Mary Nabwera also contributed her personal car worth Sh.250,000 to
Mary Nabwera hair salon
Balance sheet
as at 2
nd
May, 2015
ASSETS LIABILITIES
Ksh. Ksh.
Furniture 30,000 Capital 130,000
Cash at bank 100,000
130,000 130,000
109
the business. After this transaction, the balance sheet of the business would appear as
follows.
Thus, the eect of this transactions is to:
(i) Increase asset, motor vehicle by Sh. 250,000.
(ii) Increase liability, capital by Sh. 250,000.
2. Profit
Prot is the gain made by a business from its activities. It arises as a result of
selling goods or services at a price higher than the cost at which the goods or
services were bought or provided. When this happens, it leads to an increase in
the assets of the business and also an increase in the capital of the business.
Example:
On 1
st
February, 2015 Clarah started a milk supply business by contributing
Sh. 50,000 in cash to start the business. The balance sheet of her business as at
1
st
February, 2015 would appear as follows;
MARY NABWERA HAIR SALON
BALANCE SHEET
AS AT 3
RD
MAY, 2015
ASSETS LIABILITIES
Ksh. Ksh.
Furniture 30,000 Capital 380,000
Motor Vehicle 250,000
Cash at bank 100,000
380,000 380,000
CLARAH MILK SUPPLIES
BALANCE SHEET
AS AT 1
ST
FEBRUARY, 2015
ASSETS LIABILITIES
Ksh. Ksh.
Cash 50,000 Capital 50,000
50,000 50,000
Thus, the eect of this transactions is to:
(i) Increase asset, cash by Sh. 50,000.
(ii) Increase liability, capital by Sh. 50,000.
110
On 2
nd
February, 2015, she bought milk for Sh. 10,000 and sold all of it for Sh.15,000.
After this transaction, her balance sheet as at 2
nd
February, 2015 would appear as
follows:
It will be noted that the amount of cash has increased by Sh. 5,000. This is the prot
made from the sale of the milk. On the other hand the capital has also increased by Sh.
5000 as a result of the same prot.
The eect of prot on the balance sheet is therefore to:
• Increase assets
• Increase capital
(b) Transactions that result in a decrease in the capital
Just as there are transactions that result to increase in capital, there are also
transactions that result in a decrease in the capital of a business. These include
the following:
1. Drawings
The term drawings refers to money, goods or services of the business used by
the owner for personal purposes without paying for them. Such money, goods
or services withdrawn or used for personal purposes reduce the capital. The
example given below illustrates this.
Example:
The proprietor of Clarah Milk Supplies realised that she had made a prot of Sh.5,000.
Hence on 3
rd
February, 2015, she took Sh. 2,500 cash from the business and used it to
shop for goods she used in her house for personal needs. After this transaction, her
CLARAH MILK SUPPLIES
BALANCE SHEET
AS AT 2
ND
FEBRUARY, 2015
ASSETS LIABILITIES
Ksh. Ksh.
Cash 55,000 Capital 50,000
Add prot 5,000
55,000 55,000
CLARAH MILK SUPPLIES
BALANCE SHEET
AS AT 3
RD
FEBRUARY, 2015
ASSETS LIABILITIES
Ksh. Ksh.
Cash 52,500 Capital 55,000
Less Drawings 2,500
52,500 52,500
111
balance sheet of the business as at 3
rd
February 2005 will appear as follows:
From the balance sheet, it will be noted that as a result of the drawings of Sh. 2,500 (i.e.
the money taken by Clarah for her personal shopping) the asset, cash has reduced by
Sh. 2,500, while the capital has also decreased by Sh. 2,500.
• Decrease assets
• Decrease capital
2. Loss
Loss in a business arises when a business sells goods or services at a price less than the
cost of the goods or services. Such a situation may arise when:
• goods bought for sale get damaged before they are sold forcing the seller to sell
them at a price lower than the cost at which they were bought.
• the selling price of the goods in the market fall below the buying price due to
various factors.
The example given below illustrates the eect of loss on a balance sheet,
Example:
Mwatela started a business known as Mwatela Fashions to trade in clothes on 2
nd
June, 2015. On this date, he provided Sh. 20,000 in cash to start the business. His
balance sheet as at this date was as follows:
On 3
rd
June, 2015, the business purchased some shirts for Sh. 10,000. While in the
shop for sale, all the shirts were accidentally stained by wet paint. As a result,
Mwatela sold all the shirts on 5
th
June 2015 for sh. 8,500, thus, making a loss of Sh.
1,500. The balance sheet of his business as at 5
th
June, 2015 after the transaction
MWATELA FASHIONS
BALANCE SHEET
AS AT 2
ND
JUNE, 2015
ASSETS LIABILITIES
Sh. Sh.
Cash 20,000 Capital 20,000
20,000 20,000
MWATELA FASHIONS
BALANCE SHEET
AS AT 5
TH
JUNE, 2015
ASSETS LIABILITIES
Ksh. Ksh.
Cash 18,500 Capital 20,000
Less Net Loss 1,500
18,500 18,500
112
would appear as follows:
From the balance sheet above, it will be noted that as a result of selling the shirts at the
loss of Sh. 1,500 the asset, cash has decreased by Sh. 1,500 and likewise, the capital has
decreased by Sh. 1,500.
• Decrease asset
• Decrease capital
Initial and nal capital of a business
Initial capital - capital at the start of a business
Final capital is capital at the end of trading period
Example 1:
Study the two balance sheets of Gikomba Enterprises given below.
A comparison between the two balance sheets reveals the following:
(i) There is a decrease in capital from the initial capital of Sh. 50,000 to the nal capital
of Sh. 40,000. The decrease is Sh. 10,000.
(ii) There is a decrease in debtors from Sh. 10,000 to zero. This means the debtors
paid their debt of Sh. 10,000.
(iii) Though the debtors paid their debt of Sh. 10,000, there is no corresponding increase
in the cash, instead, there is a decrease in the capital of Sh. 10,000.
(iv) The implication of this could be that the decrease in capital is a result of the
proprietor withdrawing the money paid by the debtors in cash for personal use.
In a situation where the comparison between the initial capital and nal capital is
an increase, such an increase may be either a result of a prot made by the business
or additional capital injected into the business by the proprietor. Now study the
following example carefully.
GIKOMBA ENTERPRISES
BALANCE SHEET
AS AT 1
ST
MARCH, 2015
ASSETS LIABILITIES
Ksh. Ksh. Ksh.
Ksh.
Fixed Assets: Capital 50,000
Machinery 100,000
Equipment 20,000 Long term Liabilities:
120,000 Bank Loan 60,000
Current Assets: Current Liabilities:
Debtors 10,000 Creditors 20,000
Cash 20,000 Bank overdraft 20,000
30,000 40,000
150,000 150,000
113
GIKOMBA ENTERPRISES
BALANCE SHEET
AS AT 28
TH
FEBRUARY, 2016
ASSETS LIABILITIES
K sh. Ksh. Ksh. Ksh.
Fixed Assets: Capital 40,000
Machinery 100,000
Equipment 20,000 Long term Liabilities:
120,000 Bank Loan 60,000
Current Assets: Current Liabilities:
Cash 20,000 Creditors 20,000
Bank overdraft 20,000
140,000 140,000
Example 2:
The balance sheet of a business showed an initial capital of Sh. 300,000. At the end
of the trading period, the proprietor gave the following information:
Prot made during the trading period was Sh. 50,000. Drawings made during the
trading period were Sh. 30,000. Calculate the nal capital.
In the above case, the nal capital would be calculated as follows:
Ksh.
Initial Capital 300,000
Add prot made 50,000
350,000
Less drawings 30,000
Final capital 320,000
114
Exercise 8.3
1. The balance sheet of Kevetu Enterprises as at 31
st
March, 2015 showed an initial
capital of Sh. 85,000. At 31
st
March, 2016, the following information about the
business is provided:
(i) Additional investment in the business, Sh. 30,000.
(ii) Prot made during the trading period was Sh. 60,000.
(iii) The proprietor had made monthly drawings of Sh. 3,000 from 1
st
April,
2015 to 31
st
December, 2015.
Required:
Calculate the nal capital of the business as at 31
st
March, 2016.
2. James Kopesha started business at the beginning of the year with a capital of
Sh. 320,000. At the end of the year, he provided the following information:
(i) During the year, he surrendered his private pick-up valued Sh. 350,000
to the business.
(ii) During the year, he had taken goods worth Sh. 3,600 every month for
use in his house.
(iii) The business made a prot of Sh. 160,000 for the year.
Required:
Calculate the owner’s equity at the end of the year.
3. The information given below was obtained from the business records of Ngota
Hair Salon as at 1
st
January, 2016.
Assets and Liabilities Sh.
Cash 25,000
Stock 45,000
Debtors 30,000
Land and Buildings 150,000
Furniture 80,000
Bank overdraft 20,000
Creditors 45,000
At the end of the trading period, the following additional information is available:
(i) The proprietor made drawings of Sh. 2,000 per month for the whole year.
(ii) The prot made for the year was Sh. 10,000.
(iii) Additional investment by the proprietor in the year was Sh. 60,000.
Required:
(a) Calculate the initial capital as at 1
st
January, 2016.
(b) Calculate the nal capital as at 31
st
December, 2016.
115
KIMALAT PROVISION STORE
BALANCE SHEET AS AT 31
ST
DECEMBER 2015 and 2016
ASSETS
Fixed assets:
Fixtures and ings 7,000 10,000
Delivery vehicles 80,000 80,000
87,000 90,000
Current Assets:
Stock 35,000 30,000
Debtors 50,000 40,000
Cash at bank 40,000 45,000
Cash in hand 10,000 15,000
135,000 130,000
222,000 220,000
LIABILITIES
Capital 197,000 197,000
Current Liabilities:
Trade creditors 20,000 20,000
Other creditors 5,000 3,000
25,000 23,000
222,000 220,000
Ksh.
2015 2016
Ksh. Ksh. Ksh.
Kimalat also gave the following additional information:
(i) He invested an additional Sh. 5,000 cash in the business in January, 2016.
(ii) The business had made a prot of Sh. 74,000 in the year 2015, and Sh. 65,000
in the year, 2016.
Based on the information from the two balance sheets and additional
information given:
(a) Explain the most likely reason for the change in the value of the total
xed assets.
(b) State the net worth of the business.
(c) Kimalat would like to sell the business at the price of Sh. 200,000, and
will not take any of the assets including the cash at bank and cash in
hand. He will also not pay any of the liabilities.
Case Study
Mwanaisha would like to buy the business, which has been operated by Kimalat
for the last two years under the name Kimalat Provision Store. To help her make
up her mind, Kimalat has provided her the balance sheet of the business for the
two years as given below.
116
TRANSACTION
Sold 10 kg of sugar at Ksh. 50 per kg for
cash
Bought 50 packets of milk on credit from
Maziwa Suppliers at Ksh. 5 per packet
500
250
VALUE
(Ksh.)
DATE
2015
April 27
April 28
TRANSACTION EFFECT ON
BALANCE SHEET
Sold sugar for cash 500
500
AMOUNT
(Ksh.)
DATE
2015
April 27 Decrease asset stock.
Increase asset cash in
hand
Explain why it would be advisable for Mwanaisha to buy the
business under these terms.
(d) Advice Mwanaisha on how to make sure that the business expands
in the future without having to invest more capital in the business
or take loans to invest in the business.
Practical Activity
This practical activity is a continuation of the practical activity in chapter 7, No.
1. You should therefore remain in the same team in which you were.
1. Choose one of the businesses you visited in your group. Visit the business
again and observe the business activities that take place. During this time,
record at least ve business transactions that take place involving assets,
liabilities and capital only. Record the transactions in a table similar to the
one shown below. An example has also been shown in the table.
2. After recording the transactions, meet with the rest of the members of your
group and carry out the following activities:
(a) Classify all the transactions and record them in two categories, namely:
(i) Cash transactions.
(ii) Credit transactions.
(b) For each category of transactions, discuss and work out the eect each
transaction would have on the balance sheet of the business and record
in a table similar to the one given below. An example is given.
(i) Cash transactions
117
3. Meet as a team and compare the value of cash transactions and credit
transactions and make a report on:
(a) Which category of business transactions are preferred by most of the
businesses visited.
(b) Which businesses prefer credit transactions?
(c) Which businesses prefer cash transactions?
(d) Draw a conclusion on the major category of transactions preferred
and the type or level of businesses that prefer them.
Revision Questions
1. Dene the term, business transaction in relation to the keeping of business
nancial records.
2. Identify seven types of business transactions that may take place in a
business.
3. Distinguish between a cash transaction and a credit transaction.
4. Mr Majani started business on 1
st
January, 2015 by contributing Sh. 50,000
in cash from his personal savings. He then carried out the following
transactions:
January 2: Bought a business stall for Sh. 30,000 and paid cash.
January 3: Bought some business equipment on credit from Nyanza
Furniture Dealers for Sh. 5,000.
January 5: Bought a bicycle for the business for Sh. 7,000 from Cycle Mart
and paid cash for it.
January 10: Made a part payment of Sh. 3,000 in cash for the equipment
purchased on credit.
(a) State the eect of each of the above transactions on the balance sheet
of the business, indicating the amount in each case.
(b) Draw up the balance sheet of the business as at 11
th
January, 2015.
5. For each of the transactions given in the table on page 158, state whether
the transaction will cause an increase or decrease in assets, liabilities or
capital on the balance sheet. The rst one has been done as an example.
6. J. Mwaniki’s balance sheet had the following items as at 1
st
January, 2016.
118
TRANSACTION
(a) A debtor paid the amount
owing by cheque.
(b) Bought a business machine
on credit.
(c) Paid a creditor the amount
owing in cash.
(d) The proprietor invested more
money in the business by cheque.
(e) Borrowed money from a bank
to expand the business, receiving
the money by cheque.
(f) Bought oce furniture for the
business and paid cash.
Asset, debtors
EFFECT ON BALANCE SHEET
Asset, cash at
bank
INCREASE DECREASE
Creditors Sh. 54,000; Debtors Sh. 19,625; Stock Sh. 13,500; Capital Sh.
160,000; Cash at bank Sh. 100,875; Shop building Sh. 130,000 and bank loan
Sh. 50,000.
The following transactions took place during the rst week of business
ending 8
th
January, 2016.
(i) Purchased a delivery van and paid by cheque Sh. 80,000.
(ii) Paid bank loan Sh. 10,000 by cheque.
(iii) Received a cheque for Sh. 15,000 from a debtor.
(iv) Paid a creditor Sh. 20,000 by cheque.
(v) Received Sh. 2,000 in cash from another debtor.
(a) State the eects of each of the above transactions on the balance sheet.
(b) Draw up the balance sheet of J. Mwaniki as at 8
th
January, 2016 after the
above transactions.
7. The balance sheet of Tamu Tamu Enterprise as at 1
st
May, 2015 is given on
page 161:
The following transactions took place in the business:
May 2: Paid creditors by cheque Sh. 9,000.
119
ASSETS LIABILITIES
Ksh. Ksh.
Equipment 19,000 Capital 71,000
Delivery van 120,000 Loan 120,000
Stock 36,000 Creditors 19,000
Debtors 22,000
Cash at bank 13,000
210,000 210,000
May 3: Debtors paid Sh. 18,000 by cheque and Sh. 2,000 in cash.
May 4: The proprietor deposited Sh. 50,000 in to the business bank account
from a cash prize won in a competition.
May 5: Bought equipment Sh. 6,000 and paid by cheque.
May 6: Paid a creditor Sh. 7,500 by cheque.
Draw up the balance sheet of the business after the transactions above.
8. Study the two balance sheets of Charaa Enterprise given below and
answer the questions that follow.
Explain the transactions that must have taken place so as to result in the following
double eects on the balance sheet above:
TAMU TAMU ENTERPRISE
BALANCE SHEET
AS AT 1
ST
MAY, 2015
ASSETS LIABILITIES
Ksh. Ksh. Ksh. Ksh.
Fixed Assets:
Shop building 350,000 Capital 300,000
Delivery van 120,000 Bank loan 200,000
470,000
Current Assets: Current Liabilities:
Debtors 30,000 Creditors 75,000
Cash at bank 70,000
Cash in hands 5,000
105,000
575,000 575,000
CHARAA ENTERPRISES
BALANCE SHEET AS
AT 1
ST
JANUARY 2015
120
CHARAA ENTERPRISES
BALANCE SHEET
AS AT 7
TH
JANUARY 2015
ASSETS LIABILITIES
Ksh. Ksh. Ksh. Ksh.
Fixed Assets:
Shop building 350,000 Capital 400,000
Delivery van 120,000 Bank loan 100,000
Shop ings 15,000
485,000
Current Assets: Current Liabilities:
Stock 50,000 Creditors 90,000
Debtors 20,000
Cash at bank 20,000
Cash in hands 15,000
105,000
590,000 590,000
(a) Increase in shop ings and increase in creditors.
(b) Increase in stock and decrease in cash at bank.
(c) Increase in capital and decrease in bank loan.
(d) Increase in cash in hand and decrease in debtors.
9. State two ways by which capital of a business could:
(a) increase.
(b) decrease.
121
9 9
A ledger is a book in which records of all business transactions are
kept. The record relates to various accounts.
Ledger Account
Anaccountcanbedenedasanhistoricalrecordofallthechanges
that have taken place in the value of a particular asset, liability or
capital of a business over a given trading period, resulting from
business transactions.
The importance of a an account
An individual account in the ledger is important to a business in
the following ways:
(i) It gives a detailed historical account or explanations of all
Specic objectives
By the end of this topic, the learner should be able to:
(a) Explain the meaning and purpose of a ledger;
(b) Explain the concept of double entry;
(c) Explain the meaning and format of a ledger account;
(d) Explain the rules of recording business transactions in
ledger accounts;
(e) Record business transactions in various ledger accounts;
(f) Describe the procedure of balancing a ledger account;
(g) Balance off a ledger account;
(h) Extract a trial balance from ledger account balances;
(i) Explain the purposes and limitations of a trial balance;
(j) Classify accounts;
(k) Discuss the various types of ledgers.
The Ledger
122
the changes that have taken place in the value of the particular asset, liability or
capital.
(ii) It gives information on the value of the particular asset, liability or capital at any
time need may arise. The balance on the account represents the value of the asset,
liability or capital.
(iii) The balances on each account facilitates the calculation of prot or loss and the
preparation of other nancial statements including the balance sheet at the end
of a trading period.
(iv) The information or records contained in an account provides data and information
for future reference and follow-up whenever need arises.
(v) The records i.e. entries in the account, provide evidence or proof of the occurrence
of transactions.
The format of an account
An account is divided into two sides namely: The Debit side (Dr) and the Credit side
(Cr). The diagram given below shows the format of an account.
From the diagram above:
(a) Account name: This is where the name of the account involved is wrien.
(a) The Date columns: This is the column in which the date on which the transaction
took place is recorded.
(b) The Particulars columns: These are also known as the details column. They are
used to write brief details or particulars of the transactions.
(c) The Folio columns: These are used to record the reference page the account can
be found in the ledger.
(d) The Amount column: These columns is used to record the amount of money
involved in the transaction.
The concept of double entry
The double entry concept states that for every transaction that takes place, there is a
dual eect aecting at least two account.one account gives while the other account
receives. When making records in the accounts involved, the account receiving will be
debited while the account giving will be credited.
Example
On 2
nd
February 2017 equipment was purchased for ksh25000 cash.
In this transaction, the account involved are cash in hand and equipment.
(i) The account receiving is the equipment account.
(ii) The account giving is the cash in hand account.
The entries to be made will be;
DEBIT SIDE ACCOUNT NAME CREDIT SIDE
Folio
Date
Particulars
(Details)
Amount
Date
Particulars
(Details)
Folio
Amount
123
(i) Debit (or) equipment account.
(ii) Credit (or) cash in hand account.
DR EQUIPMENT CR
Date 2017 particulars Amount Sh Tate 2017 particulars Amount sh
Feb2 Cash in
hand
25000
DR CASH IN HAND CR
Date 2017 particulars Amount shs date particulars Amount Shs
Feb2 equipment 25000
Rules for recording business transactions in accounts
The process of entering information in an account is called posting.
(i) When making entries in the ledger accounts, the name of the account in which
the corresponding entry is to be found, is wrien in the particulars column. In
this example it will be noted that:
(a) When making the debit entry in the cash account, the word ‘capital’ is
wrien in the particulars column. This is because the corresponding credit
entry is to be found in the capital account.
(b) When making the credit entry in the capital account, the word ‘cash’ is
wrien in the particulars column. This is because the corresponding debit
entry (referred to above) is to be found in the cash account.
This system of recording entries makes it easy to counter-check and ensure that proper
double entry has been completed for each transaction.
Another example is given below to further illustrate the procedure in recording the
eects of transactions in the ledger.
Example:
On 3
rd
January, 2016, Baraka Enterprises bought furniture for Sh. 15,000 and paid cash.
The entries arising from this transaction will be worked out as follows:
Date Effect of
transaction
Ledger accounts
affected
Entries to
be made
Jan 3
(a) Increase in
asset furniture,
Sh. 50,000
(a) Asset, furniture
account
Sh. 15,000
(a) Debit asset furniture
account Sh. 15,000
(b) Decrease in
asset cash,
Sh. 15,000
(b) Asset cash
account
Sh. 15,000
(b) Credit asset, cash
account Sh. 15,000
124
DR. CASH ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details
Amount
Ksh.
Jan 2 Capital 50,000 Jan 3 Furniture 15,000
The entries in the ledger accounts will appear as follows:
Worked Example 1
The following transactions of Baraka Enterprises are used to illustrate the double
entry principle.
Transactions:
2016:
Jan 2: Baraka started a business known as Baraka Enterprises, contributing Sh.
50,000 in cash from his personal savings.
Jan 3: Baraka Enterprises bought furniture for Sh. 15,000 and paid cash.
Jan 4: Baraka Enterprises bought some weighing equipment on credit from
Weights and Measures Ltd for Sh. 25,000.
Jan 5: The business paid Weights and Measures Ltd. Sh. 15,000 in cash.
Jan 6: Sold some of the furniture in cash at Sh. 5,000
Jan 8: Sold some of the weighing equipment on credit to Mukoya Investments at
the cost price of Sh. 8,000.
Jan 9: Mukoya Investments paid part of the debt in cash Sh. 5,000.
Jan 10: Baraka turned his personal motor vehicle worth sh. 250,000 for business
use.
DR. FURNITURE ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 3 Cash 15,000
125
The eect of each of the above transactions can be worked as follows:
OF TRANSACTION
date Accounts
involved
Receiving account Giving account Entries to
be made
2 Capital cash cash capital Dr.cash
Cr.capital
3 Furniture cash furniture cash Dr.furniture
Cr.cash
4 Weighing
equipment
Creditors:
Weight and
measures ltd.
Weigh equipment Weights and
measures ltd.
Dr.weighing
equipment
Cr.weights and
measures ltd.
5 Weights and
measures ltd.
Weights and
measures ltd.
cash Dr.weights and
measures
Cr.cash
6 Cash furniture cash furniture Dr.cash
Cr.Furniture
7 Debtors:mukoya
investments
weighing
equipment
Mukoya
investment
Weighing
equipment
Dr.mukoya
investments
Cr.weighing
equipment.
8 Cash mukoya
investment
cash Mukoya
investment
Dr.cash
Cr.mukoya
investment
9 Motor vehicle
capital
Motor vehicle capital Dr.motor vehicle
Cr.capital
10
126
The entries in the ledger accounts would appear as follows:
DR. CASH ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 2 Capital 50,000 Jan 3 Furniture 15,000
Jan 6 Furniture 5,000 Jan 5 Weights and
Jan 9 Mukoya Measures Ltd. 15,000
Investment 5,000
DR. CAPITAL ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 2 Cash 50,000
Jan 10 Motor vehicle 250,000
DR. FURNITURE ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 3 Cash 15,000 Jan 6 Cash 5,000
DR. WEIGHING EQUIPMENT ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 4 Weights and Jan 8 Mukoya Investments 8,000
Measures Ltd. 25,000
DR. CREDITORS: WEIGHTS & MEASURES LTD. ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 5 Cash 15,000 Jan 4 Weighing
equipment. 25,000
127
Worked Example 2
The following is the balance sheet of Waiyaki Stores as at January, 2016.
The business carried out the following transactions in the month of February, 2016.
February 1: Bought a bicycle for the business use at Sh. 13,000 on credit from
Cycle Mart Company.
February 2: Paid Mwaura Distributors Sh. 5,000 by cheque.
February 9: Sold some of the furniture for the original cost of Sh. 10,000 in cash.
DR. DEBTORS: MUKOYA INVESTMENT ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 8 Weighing 8,000 Jan 9 Cash 5,000
Equipment
DR. MOTOR VEHICLE ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 10 Capital 250,000
WAIYAKI STORES
BALANCE SHEET
AS AT 31
ST
JANUARY 2016
ASSETS LIABILITIES
Ksh. Ksh. Ksh. Ksh.
Fixed Assets: Capital 122,550
Furniture 24,300
Equipment 15,600
39,900
Current Assets: Current Liabilities:
Debtors: Creditors:
J. Maina 7,250 Mwaura Distributors 8,700
S. Mwela 8,100
Cash at bank 76,000
91,350
131,250 131,250
128
February 15: Deposited Sh. 9,000 from the cash in hand into the business bank
account.
February 20: Received a cheque for Sh. 7,500 from S. Mwela.
Required:
(a) Open the ledger accounts of Waiyaki Stores.
(b) Record the above transactions in the ledger accounts of the business.
(c) Draw up the balance sheet of the business as at 20
th
February, 2016.
DR. FURNITURE ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 31 Opening balance 24,300 Feb 9 Cash in hand 10,000
DR. EQUIPMENT ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 31 Opening balance 15,600
DR. J. MAINA (DEBTOR) ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details
Amount
Ksh.
Jan 31 Opening balance 7,250
DR. S. MWELA (DEBTOR) ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 31 Opening balance 8,100 Feb 20 Cash in hand 7,500
129
DR. CASH AT BANK ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 31 Opening balance 76,000 Feb 2 Mwaura Distributors
5,000
Feb 15 Cash in hand 9,000
Feb 20 S. Mwela 7,500
DR. CAPITAL ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 3 Opening balance 2,550
DR. MWAURA DISTRIBUTORS (CREDITOR) ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details
Amount
Ksh.
Feb 2 Cash at bank 5,000 Jan 3 Opening balance 8,700
DR. BICYCLE ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Feb 1 Cycle Mart Company 13,000
DR. CYCLE MART COMPANY (CREDITOR) ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Feb 1 Bicycle 13,000
130
Note: In drawing up the balance sheet above, the nal values of each asset, liability
and capital have been worked out from the accounts by geing the dierence
between the total debit entries and the total credit entries in each account, i.e. the
balances in each account.
DR. CASH IN HAND ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Feb 9 Furniture 10,000 Feb 15 Cash at bank 9,000
WAIYAKI STORES
BALANCE SHEET
AS AT 20
TH
FEBRUARY 2016
ASSETS LIABILITIES
Ksh. Ksh. Ksh. Ksh.
Fixed Assets: Capital 122,550
Furniture 14,300
Equipment 15,600
Bicycle 13,000
42,900
Current Assets: Current Liabilities:
Debtors: Creditors:
J. Maina 7,250 Mwaura Distributors 3,700
S. Mwela 600 Cycle Mart Co. 13,000
Cash at bank 87,500 16,700
Cash in hand 1,000
96,350
139,250 139,250
131
Class work Exercise 9.1
1. Using a table similar to the one given below, identify the account to
be debited and the account to be credited in each of the following
transactions.
(a) Purchased equipment on credit from
Ochanda Manufacturers.
(b) A customer, P. Okoth paid his debt
in cash.
(c) Borrowed money from the Co-
operative Bank to expand business.
The money was received by cheque.
(d) Paid a supplier, Central Stores Ltd. for
goods supplied on credit in cash.
(e) Returned some of the equipment
bought on credit from Ochanda
Manufacturers.
(f) The proprietor introduced into the
business more money by cheque
from personal savings.
(g) Bought shop xtures for cash.
(h) Took cash from the business bank
account to be used in the business.
(i) Received a cheque from Jane Chao,
cash in payment of her debt.
(j) Paid cash into the business bank
account from the cash in the oce.
Transaction
Account to be
debited
Account to
be credited
2. Using a table similar to the one given above, state the account to be
debited, the account to be credit and the respective amounts for each of the
transactions that took place in Charo’s business given on the next page.
132
Charo started business with
Sh.50,000 in cash.
(b) He bought a motor van for
Sh.300,000 on credit from Simba
Motor Company.
(c) He bought oce furniture for
Sh. 10,000 in cash.
(d) He opened a business bank
account and deposited half
of all the cash in hand after
purchasing the oce furniture.
(e) He borrowed Sh. 400,000 from
Business Finance Company to
invest in the business. He got
the money by cheque.
(f) He paid Simba Motor Company
their debt by cheque.
(g) He bought a delivery van from
Simba Motor Company for
Sh.250,000. He paid by cheque
Sh. 100,000 and the balance to be
paid later.
Transaction
Account to
be debited
Amount
Sh.
Account
to be
credited
Amount
Sh.
(a)
3. Mwana Biashara started a business known as Biashara Stores on
1
st
January, 2016, by contributing the following assets into the business:
Sh.
Cash at bank 50,000
Furniture 25,000
During the month of January, 2016, the following transactions took place:
Jan 2: Bought business equipment for Sh. 15,000 by cheque.
Jan 4: Withdrew Sh. 5,000 from the bank for oce use.
Jan 5: Bought a delivery bicycle on credit for Sh. 4,000 from Cycle Mart Retail
Traders.
Jan 6: Borrowed Sh. 50,000 from Mali Bank. The money was deposited in the
business bank account directly.
Jan 15: Paid Cycle Mart Retail Traders their debt by cheque.
Jan 21: Mwana Biashara increased his capital in the business by Sh. 10,000 in
cash.
Jan 25: Sold the delivery bicycle for Sh. 4,000 in cash.
133
Jan 26: Bought a new motor cycle for Sh. 20,000 by cheque.
Jan 31: Deposited Sh. 10,000 of the cash in hand into the business bank account.
Required:
(a) Determine the capital of the business as at 1
st
January, 2016.
(b) Open the ledger accounts of the business as at 1
st
January, 2016.
(c) Record the transactions above in the ledger accounts of the business.
4. The following is a balance sheet of Kamuluu Enterprises.
The following transactions took place during the month of March, 2016:
March 2: Kamuluu, the owner of the business, invested a further Sh. 50,000
cash in the business.
March 3: Some of the oce equipment was sold on credit to S. Karanja for
Sh. 20,000.
March 4: Paid A. Mutiso the amount due cash.
March 8: Bought oce equipment for Sh. 20,000 and paid cash.
March 15: J. Mweu paid Sh. 30,000 by cheque.
March 20: Received a loan from Kiambati Finance Company Sh. 40,000 by
cheque.
March 26: Withdrew Sh. 5,000 from the bank for oce use.
March 29: Bought more oce equipment for Sh. 10,000 from Classic Furniture
Mart and paid by cheque.
KAMULUU ENTERPRISES
BALANCE SHEET
AS AT 1
ST
MARCH, 2016
ASSETS LIABILITIES
Fixed Assets: Ksh. Ksh. Ksh. Ksh.
Premises 100,000 Capital 314,600
Delivery van 100,000
OfceEquipment 50,000
250,000
Current Assets: Current Liabilities:
Debtors: J. Mweu 50,850 Creditors:
Cash at bank 60,800 A. Mutiso 31,550
Cash in hand 4,500 G. Stores 20,000
116,150 51,550
366,150 366,150
134
Note the following short-comings from the stock account above:
(i) It does not reveal that the stock increases on the debit side is recorded at the buying
price, while the stock decreases on the credit side is recorded at the selling price.
(ii) At the end of a trading period, the account does not reveal whether the goods
were all sold or not.
(iii) The stock account does not reveal whether some of the changes in the stock, either
increases or decreases, are as a result of goods returned rather than new stock.
(iv) The total credit entries is greater than the total debit entries. This creates the
impression that the stock account can have a credit balance. Stock is an asset and
therefore should have debit balances.
In order to avoid this kind of confusion that arise in using only one stock account, the
asset stock account is sub-divided into several stock accounts as follows:
Required:
(a) Open the ledger accounts of the business as at 1
st
March, 2016.
(b) Record the above transactions in the ledger accounts of the business.
(c) Draw up the balance sheet of the business as at 31
st
March, 2016.
Transactions involving asset stock
Stock refers to the goods in the business for sale with the aim of making prot. Thus
the term stock refers only to items goods that form the main line of business of an
organisation. These are the items or goods traditionally bought and sold by the
business with the purpose of making a prot. Asset stock is therefore very important
to a business and should be given special aention.
We have discussed the purpose of an account i.e. to keep track or a record of all the
changes that take place in a given asset or liability. These changes consist of increase
and decrease in the value of the assets or liabilities arising from business transactions.
We have learnt that for each asset and liability in the business, a separate account is
opened.
However, changes that take place in the asset stock cannot be recorded in only
one stock account. If only one account is used to keep a record of all the changes
aecting stock, the account would give misleading and confusing information. This
would make it dicult to calculate and determine whether prot or loss is made. To
illustrate this, study the stock account given below carefully:
DR. STOCK ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 2: Bank 50,000 Jan 3 Cash 30,000
Jan 8: J. Gitau 5,000 Jan 5 J. Gitau 30,000
J an 10 Cash 2,000
135
(a) The purchases account
This is the stock account which keeps a record of all goods purchased for resale. It is
used to record stock increase through purchase. Every time stock is purchased, the
purchases (stock) account is debited at the buying price. In order to avoid confusion
with the stock account, the term stock is dropped. The account is therefore simply
referred to as a purchases account. For example, goods purchased for resale on 2
nd
January, 2016 by cheque Sh. 50,000 would be recorded as follows:
(b) The sales account
This is the stock account in which the sale of goods is recorded. It is used to record the
decreases of stock through sale. When goods are sold, this account is credited at the
selling price.
For example, some of the goods purchased on 2
nd
January, 2016 above maybe sold
as follows:
Jan 3: Sold in cash Sh. 30,000
Jan 5: Goods sold on credit to J. Gitau Sh. 30,000
This would be recorded in the sales account as follows:
(c) The purchases returns account
This is the stock account in which goods purchased and returned back to the
supplier are recorded. This could happen for various reasons such as the goods being
damaged when received from the supplier. Such goods are also referred to as returns
outwards. Hence, this account is also called Returns Outwards Account. When
goods are returned to the supplier, this represents a decrease in the asset stock, hence,
the purchases returns account is credited with the value of the goods returned or the
DR. PURCHASES ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 2 Bank 50,000
DR. SALES ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 3 Cash 30,000
Jan 5 J. Gitau 30,000
136
allowance given by the supplier.
Example:
Some of the goods purchased on 2
nd
January, 2016 were found to be damaged. They
were returned to the supplier and a cash refund of Sh. 2,000 made by the supplier.
This would be recorded as follows:
(d) The sales returns account
This is the stock account which records goods sold and returned by customers.
Similar to purchases returns, goods sold could be returned by customers for various
reasons such as damaged goods supplied to customers. Such goods are referred to
as returns inwards. Hence, the account is referred to as Returns Inwards Account.
Goods returned by customers represent an increase in asset stock, hence the sales
returns account is debited with the value of the goods returned or the allowance given
to the customers for the goods returned.
Example:
On January 8, J. Gitau returned some of the goods sold to him and was given an
allowance of Sh. 5,000. This would be recorded as follows:
(e) The stock account
After moving the above aspects of the stock into separate accounts, the stock account
is left to deal with only one aspect of goods for sale. It is left to keep a record of only
the amount of goods that remain unsold in the business at the end of a trading period.
Entries in this account are made at the end of a trading period when the prot or loss
made by the business is being calculated.
DR. PURCHASES RETURN ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 10 Cash 2,000
DR. SALES RETURNS ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 8 J. Gitau 5,000
137
Recording transactions involving asset stock
We now know that there are ve accounts used to keep a record of the changes that
take place in asset stock resulting from transactions involving stock. We shall discuss
the records made in the purchases account, purchases returns account, sales account
and the sales returns account. Records made in the stock account will be discussed
later.
When making entries in the various stock accounts, it should be remembered that
they are all asset accounts. Therefore, the rules that are observed when making entries
in asset accounts apply to these accounts. These rules are summarised as follows:
The examples given below illustrates the application of these rules.
Example 1:
When stock in business increases,
debit:
•Purchasesaccount
•Salesreturnsaccount
DEBIT CREDIT
When stock in business decreases,
credit:
•Salesaccount
•Purchasesreturnsaccount
Transaction
Effect on asset stock
Entries to be made
(a) Purchasing of goods
for sale on credit
from R. Njoya
(i) Increase in asset stock
(ii) Increase in the liability,
creditors, R. Njoya
(i) Debit the purchase
account
(ii) Credit creditors R.
Njoya account
(b) Goods purchased
for cash
(i) Increase in asset stock
(ii) Decrease in asset cash
(i) Debit purchases
account
(ii) Credit cash account
(c) Returned goods
to R. Njoya
(i) Decrease in liability,
creditor R. Njoya
(ii) Decrease in asset stock
(i) Debit creditor R.
Njoya account
(ii) Credit the purchases
returns account
(d) Goods were
sold for cash
(i) Increase in asset cash
(ii) Decrease in asset stock
(i) Debit cash account
(ii) Credit sales account
(e) Goods were sold on
credit to Jane Mutiso
(i) Increase in asset
debtor, Jane Mutiso
(ii) Decrease in asset stock
(i) Debit debtor
Jane Mutiso
(ii) Credit sales account
(f) A customer returned
goods sold to her
for cash and was
refunded her money
(i) Increase in asset stock
(ii) Decrease in asset cash
(i) Debit purchases
returns account
(ii) Credit asset
cash account
138
Example 2:
Enter the following transactions in the ledger accounts of Wanainchi Traders.
2016
May 1: Started business with sh. 50,000 cash.
May 2: Bought goods on credit from L. Macho for Sh. 38,500.
May 4: Sold goods in cash Sh. 20,000.
May 5: Bought more goods in cash sh. 15,000.
May 8: Returned some of the goods purchased from L. Macho for sh. 2,500.
May 10: Sold goods on credit to A. Onalo for sh. 24,000.
May 15: A. Onalo returned some of the goods worth Sh. 4,000.
Answer (Example 2)
DR. CASH ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
May 1 Capital 50,000 May 5 Purchases 15,000
May 4 Sales 20,000
DR. CAPITAL ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
May 4 Cash 50,000
DR. PURCHASES ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details
Amount
Ksh.
May 2 L. Macho 38,500
May 4 Cash 15,000
DR. L. MACHO ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details
Amount
Ksh.
May 8 Purchases Returns 2,500 May 2 Purchases 38,500
139
Class work Exercise 9.2
1. Identify the account to be debited and the account to be credited in each
of the following transactions:
(a) A loan was paid by cheque.
(b) Premises were bought and paid for by cheque.
(c) Goods were sold for cash.
(d) Goods were sold on credit to S. Mwendwa.
(e) A cheque was sent to L. Munala who had supplied goods on credit.
(f) Goods were returned by S. Choko, a customer.
(g) Surplus shop ings were sold and payment received by cheque.
DR. SALES ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
May 4 Cash 20,000
May 10 A. Onalo 24,000
DR. PURCHASES RETURNS ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
May 8 L. Macho 2,500
DR. A. ONALO ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details
Amount
Ksh.
May 10 Sales 24,000 May 15 Sales returns 4,000
DR. SALES RETURNS ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details
Amount
Ksh.
May 15 A. Analo 4,000
140
(h) Goods were bought on credit from A. Okello.
(i) Oce cash was deposited into the business bank account.
(j) Faulty goods were returned to A. Okello.
2. Enter the following transactions in the ledger accounts of Nasirembe Ration
Store.
2016:
Oct 1: Started business with cash at bank sh. 50,000.
Oct 2: Bought goods on credit for Sh. 4,800 from J. Ireri.
Oct 3: Sold goods for cash Sh. 2,200.
Oct 5: Sold goods on credit to B. Aluda for Sh. 1,750.
Oct 9: Bought goods on credit Sh. 1,450 from K. Charo.
Oct 11: Goods were bought for cash Sh. 2,000.
Oct 16: Sold goods on credit for Sh. 4,960 to J. Chege.
Oct 21: Bought goods on credit from J. Ireri for Sh. 3,700.
Oct 24: Returned goods to K. Charo and was given an allowance of
Sh. 250.
Oct 29: B. Aluda returned goods worth Sh. 440.
Oct 30: J. Chege paid the amount owing on his account by cheque.
3. Enter the following transactions in appropriate ledger accounts.
2016:
July 1: Started business with Sh. 65,000 at bank.
July 2: Bought shop goods from Obondo Suppliers Store on credit for
Sh. 12,000.
July 3: Bought goods for Sh. 39,000 from Makau Suppliers on credit.
July 4: Withdrew Sh. 10,000 from the bank for use in the oce.
July 5: Purchased goods in cash at Sh. 4,230.
July 6: Sold goods to B. Luusa on credit for Sh. 37,000.
July 8: Returned goods worth Sh. 7,000 to Makau Suppliers.
July 17: B. Luusa returned goods worth Sh. 5,000.
July 20: Paid Makau Suppliers their debt by cheque.
4. J. Martin started a business known as Martin Fashion Store, dealing in clothes
on 1
st
March, 2016 with Sh. 36,000 in cash. The following transactions took
place during the month.
March 2: Deposited Sh. 30,000 of the cash into a business bank account.
March 3: Bought two dozen shirts for sale at Sh. 1,000 per shirt on credit
from Textile Distributors.
March 4: Bought shop ings for Sh. 2,400 in cash.
March 5: Sold 10 shirts at Sh. 1,500 each. The money was received in
cash.
March 6: Sold 5 shirts on credit to L. Mutheke at Sh. 1,600 each.
March 8: Bought a delivery van for the business for Sh. 200,000 from
Kwetu Motors. The amount was to be paid for in equal
141
instalment over a period of 10 months.
March 10: Purchased 30 ladies dresses for Sh. 25,000 and paid by cheque.
March 11: Of the shirts purchased on 3 March, 5 were faulty and returned
to the suppliers.
March 12: Paid Sh. 10,000 of the cash in the oce into the business bank
account.
March 15: L. Mutheke cleared her debt by cheque.
March 17: Sold 10 dresses at Sh. 2,000 each on credit to School Uniform
Retailers.
March 24: School Uniform Retailers returned some dresses worth
Sh. 8,000.
March 25: Martin deposited into the business bank account Sh. 95,000 he
received as a prize won in a competition.
March 27: Paid the rst instalment for the delivery van by cheque.
Required:
Enter the above transactions into the ledger accounts of the business.
Transactions involving expenses
Expenses are extra costs that are paid by a business in addition to the cost of the goods
for sale. They are also known as overheads. Expenses can therefore also be dened
as overhead costs incurred by a business in the course of its business activities over
and above the cost of the goods or services for sale. Examples of expenses include
salaries and wages; expenses incurred transporting goods to customers (also known
as carriage outwards); rent; advertising; insurance; costs of packaging and packaging
materials and discounts allowed. Note that the cost of carriage of goods from suppliers
or carriage inwards increases the cost of goods purchased. It is therefore treated as
part of the cost of goods and not an overhead cost.
Expenses have the eect of reducing the prot made and hence the capital. They
must therefore be carefully watched and controlled. If they exceed the prot made
on the selling price of the goods or services, they result into a loss and therefore a
decrease in the capital invested in the business. Expenses also represent a decrease in
capital.
In order to keep watch and control over expenses, a separate account is opened for
each type of expense paid by the business. For example: rent account; salaries account,
wages account; carriage outwards account, carriage inwards account, insurance
account, advertising account and packaging account. When an expense is paid, the
eect of this transaction is to:
• Increase the expense
• Decrease the asset cash
To record this in the ledger accounts, the entries will be:
• Debit the expense account
• Credit the asset cash account
142
Keeping a separate account for each expense also makes it easy to see the eect of each
expense on the prot of the business and hence enable the management to control
the expense. The example given below illustrates how entries are made in the ledger
when expenses are paid.
Example:
The above transactions will appear as follows in the ledger accounts.
DR. RENT EXPENSE ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Feb 8 Cash at bank 25,000
DR. CASH AT BANK ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Feb 8 Rent 25,000
Transaction Effect Entries in the ledger
(a) Feb. 8, paid rent by
cheque Sh. 25,000
(i) Increase in expense-
rent Sh. 25,000
(ii) Decrease in asset
cash at bank
Sh. 25,000
(i) Debit rent expense
account Sh. 25,000
(ii) Credit asset cash at
bank account
Sh. 25,000
(b) Feb. 28, paid
salaries in cash Sh.
13,000
(i) Increase in expense
salaries Sh. 13,000
(ii) Decrease in asset
cash in hand
Sh. 13,000
(i) Debit salaries expense
account
Sh. 13,000
(ii) Credit cash in hand
Sh. 13,000
143
Transactions involving revenue
Revenue refers to money earned by a business through its business activities. Such money
isalsoknownasincomeanditincreasestheprotof thebusiness.Themainsourceof 
revenue for a business are the sales. For example, the money earned through the sale of
goods or services usually forms the main source of revenue for the business. A business
may also earn revenue from other sources or activities other than sales.
Such sources include:
(i) Discounts received.
(ii) Rentreceivedforpremisesorofcespacesub-lettootherbusinesses,peopleor
organisations.
(iii) Commissions received from services provided by the business on behalf of other
business organisations or people.
Allrevenueincomehastheeffectof increasingtheprotof thebusinessandthereforethe
capital. However, transactions involving revenues are not recorded in the capital account
directly. A separate account is opened for each revenue. For example, rent received
account, discount received account and commission received account.
When a revenue is earned or received in cash, its effect will be:
•Increaseintheassetcash
•Increaseintherevenue
Thus the entries made in the ledger accounts would be to:
•Debittheassetcash(orbank)account
•Credittherevenueaccount
The examples given below illustrate the entries made in the ledger for revenues received.
Examples:
DR. SALARIES EXPENSE ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details
Amount
Ksh.
Feb 28 Cash in hand 13,000
DR. CASH IN HAND ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details
Amount
Ksh.
Feb 28 Salaries 13,000
144
Transaction
Effect
Entries to be made
(a) Received rent
Sh.5,000 in cash for
ofcespacesub-let
to another business
(i) Increase in asset
cash in hand
Sh. 5,000
(ii) Increase in revenue
rent received Sh.
5,000
(i) Debit cash in hand
account Sh. 5,000
(ii) Credit rent received
account Sh. 5,000
(b) Received a
commission of
Sh. 25,000 by
cheque for selling a
house on behalf of
a customer
(i) Increase in asset
cash at bank
Sh. 25,000
(ii) Increase in revenue
commission
received Sh. 25,000
(i) Debit cash and bank
account Sh. 25,000
(ii) Credit commission
received account
Sh. 25,000
The above entries will appear as follows in the ledger accounts.
DR. CASH IN HAND ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Feb 8 Rent received 5,000
DR. RENT RECEIVED ACCOUNT CR.
Date
2016
Particulars/Details
Date
2016
Particulars/Details Amount
Ksh.
Feb 8 Cash in hand 5,000
Amount
Ksh.
145
Transactions involving drawings
Most people who operate small scale businesses start such business as a source of
livelihood i.e. to support their lives and families. They have to pay for their personal
needs and meet the up-keep of their families. To meet these obligations, they often
use some of the resources of the business. Such resources may be in form of cash,
services or assets of the business. They are all collectively referred to as drawings.
They include:
(i) Money withdrawn either in cash or by cheque and used to meet personal needs
of the proprietor.
(ii) Stock or goods for resale taken to be used for personal needs of the proprietor.
(iii) Other items or assets of the business other than stock. For example, furniture,
taken to be used by the proprietor for personal needs.
(iv) Services of the business like the sta of the business, being used to carry out
personal work of the proprietor and paid for the work from business money or
resources.
Drawings cause a decrease in the capital of the business. Drawings are usually made in
the hope that by the end of the trading period, the prot made will exceed the amount
of drawings made. If the total drawings at the end of the trading period exceed the
prot made for the same period, this would cause a reduction in the capital invested
in the business.
Every business person must therefore try to ensure that the drawings made do not
exceed the prot made by the business, so as to ensure that the business can survive
and grow.
In order to monitor and control the amount of drawings made, transactions
involving drawings are recorded in a separate drawings account. This makes it easy
to determine the total drawings made at the end of the trading period and compare
with the prot made by the business over the same period. When drawings are made
DR. CASH AT BANK ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Feb 9 Commission received 25,000
DR. COMMISSION RECEIVED ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Feb 9 Cash at bank 25,000
146
in form of goods, other assets or services, they are recorded at their cost value.
When drawings are made, the result is;
• Increase in drawings
• Decrease in the asset
In the ledger accounts, this would be recorded as follows:
• Debit drawings account
• Credit the asset account
The examples given below illustrate how entries are made in the ledger accounts
when drawings are made.
Examples:
Transaction Effect
Entries in the ledger
(a) The proprietor took
Sh. 1,500 in cash
to pay electricity
bill for his personal
residence.
The above entries will appear as follows in the ledger accounts;
DR. DRAWINGS ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Feb 1 Cash 1,500
Feb 2 Purchases 10,000
 Feb3 Ofcefurniture 20,000
(b) The proprietor
took some of the
stock which had
cost Sh.10,000 for
personal use.
(c) The proprietor
took some of the
ofcefurniture
valued at Sh.20,000
for use in his
residential house.
(i) Increase in
drawings by
Sh. 20,000.
(ii) Decrease in asset,
ofcefurniture
by Sh. 20,000.
(i) Debit the drawings
account Sh. 1,500.
(ii) Credit the cash
account Sh. 1,500.
(i) Increase in
drawings by
Sh.10,000.
(ii) Decrease in
asset purchases
by Sh.10,000.
(i) Increase in
drawings by
Sh.1,500.
(ii) Decrease in assets
cash by Sh. 1,500.
(i) Debit the drawings
account Sh. 10,000.
(ii) Credit the purchases
account Sh. 10,000.
(i) Debit the drawings
account Sh. 20,000.
(ii) Credit the asset,
ofcefurniture
account
Sh. 20,000.
147
DR. CASH ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Feb 1 Drawings 1,500
DR. OFFICE FURNITURE ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Feb 3 Drawings 20,000
DR. PURCHASES ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details
Feb 2 Drawings 10,000
Amount
Ksh.
Debits:
• Openingbalances in asset and
expense accounts
• Increasesinassets
• Increasesinexpenses
• Decreasesinliabilities
• Closing balances in asset and
expense accounts
Credits:
• Openingbalances in liability and
revenue accounts
• Increasesinliabilities
• Decreasesinassets
• Increasesinrevenues
• Closingbalances in liability and
revenue accounts
Summary of rules observed when making entries in ledger accounts
148
Exercise 9.3
1. Identify the account to be debited and the account to be credited in each
of the following transactions:
Transaction
(a) Paid for electricity by cheque.
(b) Paid for postage of mail in cash.
(c) The owner of the business sold a personal car
and deposited the money into the business
bank account to expand the business.
d) Received a cheque for rent.
(e) Paid for motor vehicle running expenses by
cheque.
(f) Paid cash for printing of business stationery.
(g) Paid wages by cheque.
(h) The proprietor withdrew money from the
business bank account for personal use.
(i) Paid advertising charges by cheque.
(j) Returned some of the goods purchased and
got a refund in cash.
Account to be:
Debited
Credited
149
2. Enter the following transactions in the ledger accounts of D. Kisule General
Store.
2016
March 1: D. Kisule started business by depositing Sh. 100,000 into a business
bank account from personal savings.
March 3: Bought xtures for Sh. 8,250 on credit from F. Chelagat.
March 4: Paid rent Sh. 2,000 by cheque.
March 5: Purchased goods for sale Sh. 36,250 and paid by cheque.
March 6: Paid wages by cheque Sh. 20,000.
March 8: Cash sales Sh. 81,000.
March 9: Deposited Sh. 60,000 from the oce into the business bank account.
March 10: Sold goods on credit to N. Kimani Sh. 17,000.
March 11: Bought a motor van on credit from Koru Motors Ltd. for Sh. 150,000.
March 18: Paid motor van expenses in cash Sh. 14,000.
March 24: Paid motor van insurance by cheque Sh. 8,500.
March 25: N. Kimani returned goods, which had been sold to him at Sh. 9,200.
March 28: Withdrew from the business bank account Sh. 14,000 to pay for a
personal trip.
March 30: Returned some of the goods purchased for Sh. 1,300 and received a
refund of the amount in cash.
150
Transaction
Account
to be
Debited
Amount
Ksh.
Credited
Amount Ksh.
(i) Purchased stock on credit from
Central Distributors Ltd. Sh. 50,000.
(ii) Paid Sh. 5,000 cash for transportation
of stock purchased.
(iii) Withdrew Sh. 10,000 from the
business bank account and used
the money to pay rent Sh. 8,000
and electricity bill Sh. 2,000 for the
business.
(iv) Sold goods on credit to J. Akolo for
Sh.30,000.
(v) Paid Sh.5,000 by cheque for
transportation of goods to a customer.
(vi) Sold a refrigerator on behalf of a
customer and received a commission
of Sh. 10,000 in cash.
vii) Took goods worth Sh. 8,000 for
personal use.
(viii) Took furniture worth Sh. 25,000 from
the business for personal use.
(ix) Received payment for rent Sh.30,000
by cheque.
(x) Paid J. Muthoni wages of Sh. 5,000 in
cash.
(b) Enter each of the above transactions in the relevant ledger accounts.
3. (a) Identify the account to be debited and the account to be credited
and the respective amount in each of the following transactions.
151
JANE NJUGUNA
BALANCE SHEET
AS AT 31
ST
DECEMBER, 2016
ASSETS LIABILITIES
Ksh. Ksh. Ksh. Ksh.
Fixed Assets: Capital 48,150
Furniture 25,000
Motor Cycle 14,500
39,500
Current Assets: Current Liabilities:
Debtors: Creditors:
D. Maina 9,000 S. Mwamunga 7,250
S. Njagi 9,260 T. Mutia 8,550
Cash at bank 6,190 15,800
24,450
63,950 63,950
Transactions of the business for the month of January, 2016 were as follows:
Jan 2: Bought stock on credit from Wawire Suppliers for Sh. 30,000 and paid
sh. 2,500 by cheque for transportation of the goods.
Jan 3: Sold goods in cash Sh. 50,000.
Jan 4: Sold goods on credit to D. Maina for Sh. 10,500 and paid Sh. 2,500 in cash
for transportation of the goods to the customer.
Jan 5: Returned faulty goods worth Sh. 5,000 which were bought on 2
nd
January, 2006.
Jan 10: D. Maina returned some faulty stock worth Sh. 7,500.
Jan 12: Commission received Sh. 20,000 by cheque.
Jan 14: Paid wages by cheque Sh. 10,000.
Jan 15: Cash purchases Sh. 25,000.
Jan 20: Paid T. Mutia his debt by cheque.
Jan 25: Received from D. Maina a cheque for Sh. 10,000.
Jan 30: Paid wages Sh. 15,000 by cheque.
Required:
(a) Open the ledger accounts of Jane Njuguna as at 1
st
January, 2016.
(b) Enter the above transactions in the ledger accounts of the business.
4. The following is the balance sheet of Jane Njuguna as at 31
st
December, 2016.
152
Balancing an Account
An account is balanced on a particular date in order to determine the amount remaining
bon the account after considering all the transactions that will have affected the account
up to that particular day. The procedure is as follows:
STEP1: ndthetotalof bothsidesof theaccountonthedatei.e.
(i) Total of the debit side.
(ii) Total of the credit side.
STEP2: ndthedifferencebetweenthetotalonthecreditsideandthetotalonthedebit
side i.e. (i) and (ii) above.
STEP3: place the difference on the side that is smaller in the amount when indicating it
as a balance carried down (c\d) on the date of balancing the account.
STEP4: show the totals of both sides and rule. The totals will be the same.
STEP5: place the difference i.e. the balance carried down to the side that is more in the
amount column indicating it as a balance brought down (b\d) on the following
date.
The procedure of balancing an account is illustrated in the example given below.
CASH ACCOUNT
Date 2017 particulars Amount sh. date particulars Amount sh.
Jan 2
Jan 6
Jan 9
Jan 10
Capital
Furniture
Mukoya
investment
Balance b\d
50000
5000
5000
60000
30000
Jan 3
Jan 5
Jan 9
Furniture
Weights and
measurement.
Balance c\d
15000
15000
30000
60000
NOTE:
(a) If the balance brought down on the debit balance, the account is said to have a
debit balance. The account given above has a debit balance.
(b) If the balance brought down is on the credit side, the account is said to have a
credit balance.
The trial balance
trading period.
Go to page203 for a marked example.
SINGLE COLUNM CASH BOOK
Format,
Dr. Title
date details folio amount date details folio amount
The example given below illustrates the entry of transactions into the ledger accounts,
balancing the accounts and preparation of the trial balance.
Example:
The following transactions were extracted from the records of Kwetu Enterprises for
153
the month of July, 2016.
July 1: Started business with Sh. 50,000 cash.
July 2: Deposited Sh. 40,000 into a business bank account and bought furniture for
Sh. 4,000 in cash.
July 3: Purchased goods on credit from L. Otenyo for Sh. 13,500 and paid Sh. 1,500
in cash for carriage of the goods.
July 6: Sold goods on credit to N. Obanda for Sh. 15,300 and paid Sh. 1,000 in cash
for their transportation to the customer’s premises.
July 10: Sold goods for cash sh. 8,500.
July 15: Paid wages by cheque Sh. 3,400.
July 20: N. Obanda returned faulty goods sold for Sh. 5,000.
July 21: Purchased more goods on credit from L. Otenyo for Sh. 15,000 and paid Sh.
1,500 in cash for carriage of the goods.
July 25: Returned faulty goods to L. Otenyo of Sh. 4,500.
July 28: Paid L. Otenyo by cheque Sh. 20,000.
July 29: N. Obanda seled his account in full by cheque.
July 30: Paid rent by cheque Sh. 7,000.
July 31: Received Sh. 5,000 in cash as a commission from a customer.
Required:
(a) Enter the above transactions in the ledger accounts.
(b) Balance o the accounts as may be necessary.
(c) Prepare a trial balance as at 31
st
July, 2016.
Answer
DR. CASH ACCOUNT CR.
Date
2016
Particulars/DetailsParticulars/Details Amount
Ksh.
July 1 Capital 50,000 July 2 Bank 40,000
July 10 Sales 8,500 July 2 Furniture 4,000
July 31 Commission received 5,000 July 3 Carriage inwards 1,500
July 6 Carriage outwards 1,000
July 21 Carriage inwards 1,500
July 31 Balance c/d 15,500
63,500 63,500
Aug 1 Balance b/d 15,500
Date
2016
Amount
Ksh.
154
DR. FURNITURE ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh
Jul 2 Cash 4,000
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
July 25 Returns Outwards 4,500 July 3 Purchases 13,500
July 28 Bank 20,000 July 21 Purchases 15,000
July 25 Balance c/d 4,000
28,500
28,500
Aug 1 Balance b/d 4,000
DR. L. OTENYO ACCOUNT CR.
DR. BANK ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
July 2 Cash 40,000 July 15 Wages 3,400
July 29 O. Obanda 10,300 July 28 L. Otenyo 20,000
July 30 Rent 7,000
July 31 Balance c/d 19,900
50,300 50,300
Aug 1 Balance b/d 19,900
DR. CAPITAL ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jul 1 Cash 50,000
155
DR. PURCHASES ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jul 3 L. Otenyo 13,500
Jul 21 L. Otenyo 15,000
DR. CARRIAGE INWARDS ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jul 3 Cash 1,500
Jul 21 Cash 1,500
.
DR. SALES ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jul 6 N. Obanda 15,300
Jul 10 Cash 8,500
DR. N. OBANDA ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jul 6 Sales 15,300 Jul 20 Returns inwards 5,000
Jul 29 Bank 10,300
15,300 15,300
DR. CARRIAGE OUTWARDS ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jul 6 Cash 1,000
156
DR. RETURNS INWARDS ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jul 20 N. Obanda 5,000
DR. RETURNS OUTWARDS ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jul 25 L. Otenyo 4,500
DR. RENT ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jul 30 Bank 7,000
DR. COMMISSION RECEIVED ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh
Date
2016
Particulars/Details Amount
Ksh.
Jul 31 Cash 5,000
DR. WAGES ACCOUNT CR.
Date
2016
Particulars/Details
Date
2016
Particulars/Details Amount
Ksh.
Jul 15 Bank 3,400
Amount
Ksh.
157
1. Identify whether each of the following ledger accounts would show a debit
balance or a credit balance on a trial balance and state why:
(a)Sales
(b) Salaries and wages
(c) Rent
(d) Rates
(e) Insurance
(f) Carriage inwards
(g) Carriage outwards
(h) Returns inwards
(i) Returns outwards
(j) Drawings
(k) Motor vehicle
(l) Rent revenue
(m) Peter Bwire (a customer)
(n) Nyangumi Investments, (a supplier)
(o) Purchases
KWETU ENTERPRISES
TRIAL BALANCE
AS AT 31
ST
JULY, 2016
DR CR
Sh. Sh.
Cash 15,500
Capital 50,000
Bank 19,900
Furniture 4,000
L. Otenyo 4,000
Purchases 28,500
Carriage Inwards 3,000
Sales 23,800
Carriage Outwards 1,000
Wages 3,400
Returns Inwards 5,000
Returns Outwards 4,500
Rent 7,000
Commission Received 5,000
87,300 87,300
Exercise 9.4
158
2. The following list of balances were extracted from the ledger accounts of
Mara Ration Store as at 30
th
April, 2016.
Ksh.
Sales 33,000
Salaries and wages 9,000
Rent 600
Rates 200
Insurance 175
Carriage inwards 375
Carriage outwards 500
Purchases 17,000
Sales returns 350
Electricity 250
Motor expenses 430
Advertising 70
Rent revenue 300
Purchases returns 2,000
Sundry assets 7,350
Capital invested 5,000
Drawings 4,000
Required:
Prepare the trial balance of the business as at 30
th
April, 2016.
3. The following trial balance was incorrectly prepared.
Dr. C r .
Account Ksh. Ksh.
Purchases 58,400
Sales 97,260
Purchases returns 1,400
Sales returns 1,260
Equipment 20,000
Sundry expenses 4,260
Rent and rates 5,500
Light and heat 2,300
Discount allowed 850
Discount received 650
Furniture and ings 8,800
Motor cycle 47,500
Debtors 4,950
Creditors 12,950
Drawings 15,000
Capital 66,560
Cash in hand 2,000
Cash at bank 8,000
BAHARI STORES
TRIAL BALANCE, AS AT 1
ST
MAY, 2016
159
Required:
Re-draft the trial balance correcting all errors made.
4. Baraza Kilemi sells fresh fruits. The following transactions took place in
the business for the month of May, 2016.
May 2: Commenced business with Sh. 85,000 in the business bank account.
May 3: Paid rent by cheque for Sh. 1,500.
May 5: Bought equipment and paid by cheque for Sh. 9,200.
May 6 Purchased stock for sale on credit from Ngotho Merchants for
Sh. 31,300 and from Green Grocers for Sh. 17, 700. He paid Sh. 5,000
by Cheque for the transportation of the stock.
May 7: Sold goods for cash for Sh. 21,600.
May 8: Sold stock on credit to L. Makau Sh. 26,000 and to C. Ndirangu
Sh. 8,100. He paid Sh. 3,000 cash for carriage of the goods.
May 10: Borrowed Sh. 50,000 from the Bank of Commerce to expand the
business. The money was received by cheque
May 12: Returned goods to Ngotho Merchants worth Sh. 2,000.
May 13: Paid general expenses for Sh. 1,500 in cash.
May 15: Bought goods on credit from Ngotho Merchants for Sh. 13,400.
May 18: Cash sales amounted to Sh. 3,300.
May 20: Sold some of the equipment at their cost price of Sh. 1,350 receiving
the money by cheque.
May 23: Sent cheques to: Ngotho Merchants Sh. 13,000 and Green Grocers
Sh.17,700.
May 25: Paid for electricity by cheque Sh. 4,900.
May 28: Paid Sh. 4,800 cash into the bank from the oce till.
May 29: Paid wages by cheque Sh. 3,200 and received rent from a tenant
Sh. 5,000 in cash.
May 30: Received cheques from: L. Makau Sh. 20,000 and C. Ndirangu sh. 8,100.
May 31: Took some fruits and vegetables worth Sh. 5,000 at cost price for
family use.
Required:
(a) Enter the above transactions in the ledger accounts.
(b) Balance the accounts as at 31
st
May, 2016.
(c) Prepare the trial balance of the business as at 31
st
May, 2016.
5. On 1
st
September, 2016, Jane’s Retail Shop had the following assets and
liabilities:
Cash in hand Sh. 4,000; Cash at bank Sh. 36,000;
Furniture Sh. 10,000; Debtors: J. Ngumi Sh. 5,000; S. Mwaruta Sh. 4,500; and
Creditors: Kariuki Stores Sh. 11,000; and Quick Supplies Sh. 13,500.
The following transactions took place in the business for the month of
September, 2016.
Sep 2: Purchased goods from Kariuki Stores on credit for Sh. 20,000.
160
Sep 3: Purchased goods from General Supplies Ltd. and paid by cheque
Sh.10,000.
Sep 5: Paid Kariuki Stores by cheque Sh. 11,000.
Sep 8: Returned to Kariuki Stores faulty goods at the cost price of Sh. 5,000.
Sep 10: Sold good on credit to J. Ngumi Sh. 5,000 and paid Sh. 1,000 in cash for
carriage of the goods.
Sep 14: Total cash sales amounted to Sh. 24,000.
Sep 15: Deposited Sh. 20,000 of the oce cash into the bank.
Sep 20: J. Ngumi returned goods not of the size required which had been sold
at Sh. 1,500.
Sep 24: S. Mwaruta seled her account in full by cheque.
Sep 26: Sold goods on credit to S. Mwaruta Sh. 3,000.
Sep 27: Paid wages by cheque Sh. 8,000.
Sep 29: Received Sh. 8,000 in cash for rent from a tenant.
Sep 30: Banked Sh. 8,000 cash from the oce till, and took stock worth Sh.
6,000 for family use.
Required:
(a) Calculate the capital of the business as at 1
st
September, 2016.
(b) Open the ledger accounts of the business as at 1
st
September, 2016.
(c) Enter the above transactions in the ledger accounts and balance the accounts
as at 30
th
September, 2016.
(d) Prepare the trial balance of the business as at 30
th
September, 2016.
Purpose and limitations of a trial balance
Purpose of a trial balance
The trial balance therefore serves the following purposes:
(i) It provides proof of complete double entry and the arithmetic accuracy of the
entries in the ledger accounts if it balances.
(ii) Provides summary of information in various accounts.
(iii) It provides information used to prepare nal accounts..
It is important to note that, the trial balance itself is not part of the double entry system.
It is merely a check on the accuracy of entries in the ledger accounts based on the
double entry system of recording the eect of transaction in the ledger accounts.
Errors that would cause a trial balance fail to balance
Not all errors made in the course of making entries in the ledger accounts would cause
the trial balance fail to balance. The most common errors that would cause the trial
balance fail to balance are as follows:
(i) Where a complete double entry has not been made, i.e. only one aspect of
the double entry has been made e.g. where a debit entry is made without the
corresponding and equalising credit entry being made.
(ii) Omission of an accounting trial balance.
(iii) Where wrong arithmetic is done in balancing the ledger accounts.
(iv) Where one of the balances is omied from the trial balance by error.
161
(v) Failure to keep books of accounts on double entry.
(vi) Where errors are made when transferring balances to the trial balance e.g.
• recording the balance on the wrong side of the trial balance.
• transposing a balance when transferring it to the trial balances. For example,
a balance of Sh. 679 is transferred as Sh. 697.
• writing a wrong gure when transferring a balance on to the trial balance.
(vii) Arithmetic mistakes made in addition of gures on the trial balance.
Limitations of a trial balance
It should also be noted that, the balancing of a trial balance is not proof that no errors
have been made in making entries in the ledger accounts. A trial balance therefore
cannot be used as a means to prove that no errors exist in the ledger accounts. Errors
not revealed by a trial:
(i) Error of commission
(ii) Error of commission
(iii) Error of principle
(iii) Error of original entry
(iv) Error of compensation
(v) Error of complete reversal of entries
(i) Error of omission
An error of omission occurs when a complete transaction is omied or left out.
(ii) Error of commission
This error occurs when a complete double entry is made, but one of the entries is made
in a wrong account of the same class of accounts. For example, if goods are purchased
on credit from Goma Wholesalers, the correct entries to be made should be:
• Debit purchases account
• Credit Goma Wholesalers account
However, if there was another supplier known as Goma Distributors, it is possible
to make a mistake so that instead of crediting Goma Wholesalers account, Goma
Distributors account is credited.
(iii) Error of principle
This type of error results from the lack of proper knowledge or understanding of the
principles of book-keeping. It occurs when a complete double entry is made, but one
of the entries is made in the wrong class of accounts. For example, a trader who deals
in clothes may purchase display equipment by cheque to use for displaying clothes for
sale. The correct entries to be made in this transaction should be:
• Debit Display Equipment account
• Credit Cash at Bank account
However, the debit entry may be made into the purchases account instead of the
Display Equipment account.
162
(iv) Error of original entry
Wron entry is made of books of original entry and posted to relevant ledger accounts.
For example, goods sold to a customer on credit for Sh. 5,050 may be recorded in the
invoice as Sh. 5,500. The invoice is known as a document of origin and will be used
to make entries in the ledger. As a result, a proper double entry will be made in the
correct accounts, but the amount will be Sh. 5,500 instead of Sh. 5,050 which is the
correct amount.
Thus, the incorrect amount is correctly entered in the ledger accounts due to the error
made at the point of preparing the document of origin, before entering in the books
of account.
(v) Errors of compensation
They involve a series of errors being made in the ledger accounts such that the total
sum of errors made in making debit entries equals the total sum of errors made in
making credit entries. Thus the total sum of wrong debit entries are compensated by
an equal total sum of wrong credit entries.
(vi) Error of complete reversal of entries
This type of error occurs when a complete double entry is made but the entries are
reversed, i.e. both the debit and credit entry are reversed. For example if Sh. 5,000 is paid
in cash for carriage of goods outwards, the correct entries should be as follows:
• Debit Carriage Outwards by Sh. 5,000
• Credit cash in hand by Sh. 5,000
However, a wrong but complete double entry could be made in reverse as follows:
• Debit cash in hand by Sh. 5,000
• Credit Carriage Outwards by Sh. 5,000
Classication of ledger accounts
All accounts in the ledger can be classied into three major categories namely:
• Personal Accounts.
• Real Accounts.
• Nominal Accounts.
The real and nominal accounts together form the impersonal accounts. Impersonal
accounts are accounts which do not refer to persons. This is in contrast to personal
accounts which relate to persons.
(a) Personal accounts
These are accounts which relate to persons i.e. individuals and business organisations.
Personal accounts are for debtors or creditors.
Creditors are those individuals and organisations who supply goods or services
on credit to the business. For each of the creditors, an account bearing the name of the
creditor is opened. All transactions relating to the supply of goods or services on credit
from the creditor and all payments for the goods or services supplied by the creditor
are recorded in the account. Creditors’ account will usually have credit balances.
Debtors, on the other hand, are individuals and organisations to whom the business
supplies goods or services on credit. For each debtor, an account is opened bearing
163
the name of the debtor. All transactions relating to the supply of goods or services on
credit and receipt of payment for the goods or services supplied on credit are recorded
in the account. Debtors accounts usually have debit balances.
(b) Real accounts
These are accounts which relate to real or physical items in the business. They are real
because they are physical, can be seen and counted. They include properties or assets
such as premises, buildings, furniture, equipment, ings, cash in hand and cash at
bank.
(c) Nominal accounts
The term, ‘nominal’, means existing in name only. They relate to income and expenses.
Types of Ledgers
Dierent accounts are recorded in dierent ledger accounts. These ledger accounts
include:
a) Debtors ledger
b) Creditors ledger
c) Cash book
d) Nominal ledger
e) Private ledger
g) General ledger
Debtors’
accounts
Ledger accounts
Real accounts
(Asset accounts)
Nominal accounts
(Value accounts)
Revenue
accounts
Expense
accounts
Personal accounts Impersonal accounts
Creditors’
accounts
Fig. 9.1: Classification of ledger accounts.
164
(a) The debtors ledger
This ledger is also known as a sales ledger. It is the ledger that contains only debtors
personal accounts.
(b) The creditors ledger
This ledger is also known as the purchases ledger. It contains only creditors’ personal
accounts. It is also known as purchases ledger.
(c) The cash book
This is a type of ledger that has cash in hand and cash at bank accounts only. It keeps
a record of all movements of cash in the business i.e. all in-coming cash, known as
cash received, and all out-going cash, known as cash paid. The cash in hand account
should always have a debit balance. However, the cash at bank account may sometimes
have a credit balance. More about the cash book will be discussed in the next chapter.
(d) The nominal ledger
Where it is maintained as a subsidiary ledger, the nominal ledger is used to keep a
record of all the nominal accounts. .
(e) The private ledger
This type of ledger is used to keep a record of accounts that contain condential
information usually kept by the top management of the business. This ledger would
contain the accounts relating to the owner of the business. These accounts include the
capital account and the drawings account.
(f) The general ledger
The general ledger is used to keep a record of all accounts not kept in any of the subsidiary
ledgers discussed above. These are mainly the real or asset accounts.
Fig. 9.2: Types of ledgers (sub-division of the ledger).
LEDGERS
DEBTORS LEDGER
(sales ledger)
Contains debtors
personal accounts
CREDITORS LEDGER
(purchases ledger)
contains creditors
personal accounts
PRIVATE
LEDGER
Capital a/c
Drawings a/c
NOMINAL
LEDGER
Contains:
Revenue
accounts
Expense
accounts
GENERAL
LEDGER
Real
accounts
165
Exercise 9.5
1. Using a table similar to the one given below, indicate by a tick (√) whether the
errors made in each of the following transactions would cause the trial balance
to balance or not.
TRIAL BALANCE WOULD
Balance Not balance
ERROR
2. For each of the transactions given above, give a reason for your answer.
3. Classify each of the following accounts by stating the class of account and the
type of ledger each of them belongs:
(a) A balance carried down in an account
was Sh. 50,000 while the balance
brought down in the account was
Sh. 500,000.
(b) A trader paid Sh. 2,500 in cash for
carriage of goods transported to a
customer. The entries made were:
Debit carriage inwards Sh. 2,500;
Credit cash in hand Sh. 2,500.
(c) Goods worth Sh. 3,200 were returned
to a supplier and the entries made
were:
Debit returns outwards Sh. 3,200;
Credit the supplier Sh. 3,200.
(d) One of the gures in the sales account
was found to have been wrien as
Sh. 540 instead of Sh. 450.
(e) Goods worth Sh. 650 were returned
by a customer. The customer was
refunded the money. The entries
made in the ledger were:
Debit returns inwards Sh. 650;
Debit cash in hand Sh. 650.
166
4. The transactions given below took place in Mercy Provision Store during
the month of May, 2016. Make the relevant entries in the appropriate three
column ledger account and draw up the trial balance of the business as at
31
st
May, 2016.
May 4: Commenced business with Sh. 62,000 in the bank and Sh. 1,000 cash
in hand.
May 5: Purchased a delivery motor cycle on credit from Ayuku Motors
Sh. 9,500.
May 8: Purchased shop ings and paid by cheque Sh. 2,650.
May 10: Bought goods on credit from J. Ayieta Sh. 8,800; J. Chitwa sh. 17,400
and L. Tsuma Sh. 22,000.
May 11: Cash sales total Sh. 11,000.
May 14: Paid sh. 2,600 in cash for motorcycle repairs.
May 15: Returned goods to J. Chitwa Sh. 2,400 and to L. Tsuma Sh. 2,700.
May 16: Sold goods on credit to A. Makokha Sh. 15,600 and M. Owano
Sh. 24,150.
May 18: Paid Sh. 330 in cash for stationery.
May 19: Sold goods in cash Sh. 3,750 and paid into the business bank account
sh. 5,000 in cash.
May 22: Paid Ayuku Motors his account in full by cheque.
May 24: Paid the following accounts by cheque: J. Ayieta Sh. 8,800; J. Chitwa
Sh. 10,000 and L. Tsuma Sh. 19,000.
May 25: Returned faulty shop ings and was refunded Sh. 400 in cash.
May 26: Paid electricity bill in cash Sh. 1,400.
May 30: Mercy took Sh. 2,500 in cash to pay school fees for her daughter from
the business.
May 31: Received cheques from A. Makokha Sh. 10,000 and M. Owano
Sh. 20,000.
Account Class of accounts Type of ledger
(a) Wages
(b) Purchases
(c) Purchases returns
(d) Odhiambo - a supplier
(e) Sales
(f) Returns inwards
(g) Machinery
(h) Mutiso - a customer
(i) Capital
(j) Drawings
(k) Discount received
(l) Carriage inwards
(m) Bank
(n) Carriage outwards
(o) Discounts allowed
167
Case Study
Customer Pride Store is a very busy self-service shop. The shop obtains its supplies
from many suppliers, most of whom supply their goods and services on credit.
Likewise, the number of customers who buy goods on credit from the shop are many,
most of whom are reliable and pay their accounts promptly.
The volume of cash transactions is also very high, especially the volume of cash sales.
All these transactions keep the accounting sta very busy throughout the year. The
trading year of the business ends on 31
st
December. At this date, all the ledger accounts
of the business are balanced and the trial balance prepared.
Although the proprietor of the business is generally happy and satised with the
performance and honesty of the accounting sta, she has expressed concern over the
period it takes the sta to produce a trial balance at the end of the trading year.
(a) Explain how the preparation of monthly trial balances could help to solve the
problem cited above.
(b) Suggest the reasons why, though the accounting sta are honest and ecient, it
takes a long time to prepare a trial balance at the end of the year.
(c) Explain implications of delaying preparation of trial balance to the organisation.
Revision Questions
1. Explain the concept of double entry.
2. In which column of the trial balance wil balances for the following accounts
be placed.
(a) Carriage outwards.
(b) Drawings.
(c) Returns inwards.
(d) Sales
3. State three examples of the types of accounts that would be contained in each
of the following subsidiary ledgers:
(a) General ledger.
(b) Nominal ledger.
(c) Private ledger.
4. Use the bank account transactions given on below to answer the following
questions.
(a) Balance the account as at 31
st
May, 2016.
(b) Explain the transaction that took place from 3
rd
May to 30
th
May, 2016.
(c) For each entry from 3
rd
May to 30
th
May, 2016, state the account in which
the corresponding double entry will be found, indicating whether it is
a debit entry or a credit entry.
168
5. Prepare the trial balance of General Distributors from the following list of
account balances extracted from the books of the business as at 31
st
December,
2016.
Ksh. Ksh.
Stock 2,000 Insurance 4,850
Sales 25,600 Selling expenses 17,250
Purchases 12,380 Oce expenses 15,850
Carriage inwards 1,200 Debtors 19,900
Warehouse wages 3,380 Creditors 17,360
Purchases returns 5,800 Cash in hand 1,470
Sales returns 6,200 Cash at bank 15,000
Ksh. Ksh.
Warehouse expenses 3,380 Capital 240,340
Lighting 2,400 Drawings 16,500
Rent 12,000 Land and building 112,000
Telephone expenses 800 Furniture and ings 8,000
Motor vehicles 300,000 Bank loan 278,000
Motor vehicle expenses 2,540 Carriage outwards 10,000
6. Sisi Kwa Sisi Traders had the following assets and liabilities as at 1
st
July,
2016:
Cash in hand Sh. 15,000; Cash at bank Sh. 79,200; Creditors: J. Makuti Sh. 18,300;
Debtors: J. Ivuti Sh. 16,000, M. Ganga Sh. 12,000; Delivery van Sh. 190,600; Land
and building Sh. 157,500.
During the month of July, 2016, the following transactions took place:
July 2: Bought goods from J. Makuti Sh.10,000; J. Kombo Sh. 19,500 and
N.Gatu Sh. 9,700, all on credit.
July 6: Paid for printing of stationery in cash Sh. 6,500.
July 10: Sold goods for cash Sh. 3,000.
July 12: Sold goods on credit to J. Ivuti Sh. 1,300, M.Ganga Sh. 4,700 and P.
Kambu Sh. 1,950.
DR. BANK ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
May 1 Balance b/d 35,000 May 3 Purchases 5,000
May 4 Cash 25,000 May 15 Biashara Ltd. 20,000
May20 S.Macharia  17,000May16Ofcestationery 5,000
May 25 Sales 13,000 May 26 Cash 6,000
May27 Returnsoutwards 1,500May30Ofcefurniture 12,500
169
July 15: Paid by cheque J. Makuti Sh. 18,000, J. Kombo Sh. 10,000 and N.
Gatu Sh 9,000.
July 16 : M. Ganga returned goods and was allowed Sh. 500.
July 17: Returned goods to N. Gatu and received an allowance of Sh 400.
July 21: Sold goods for cash 2,900.
July 22: Paid Sh. 20,000 into the bank from personal sources.
July 24: Bought goods on credit from N. Gatu Sh. 12,400 and R. Lamba
Sh. 8,700. Paid Sh. 3,600 in cash for carriage of the goods.
July 25: Paid postal charges Sh. 1,360 in cash.
July 28: Received cheques from J. Ivuti Sh. 13,000 and M. Ganga
Sh. 12,000.
July 29: Cash sales amounted to Sh. 5,940 out of which Sh. 440 was used to pay
for general expenses.
July 30: Paid the remainder of the cash sales of the previous day into the bank
account.
July 31: Drew from the bank Sh. 30,000 out of which Sh. 15,000 was used to pay
salaries in cash and the rest used to pay for the proprietors personal
expenses.
(a) Calculate the capital of the business as at 1
st
July, 2016.
(b) Open the relevant ledger accounts as at 1
st
July, 2016.
(c) Enter the above transactions in the ledger accounts and balance the
accounts as at 31
st
July, 2016.
(d) Prepare the trial balance of the business as at 31
st
July 2016.
170
10 10
Meaning and purpose of a cash book
Meaning of a cash book
A cash book is a special ledger that contains the cash account and the
bank account. These two accounts are the most active accounts in
every business because they are used to record all the changes that
take place in the cash in hand and the cash at bank of a business.
Many business owners try to make sure that they have full
control over these two accounts by removing them from the general
ledger and putting them in a special ledger called the cash book. The
cash book is therefore a ledger as well as a journal.
Purpose of a cash book
The main purpose of a cash book is to ensure that both the cash
account and bank account are contained in one special ledger has the
following purposes:
1. Itcontrolsthemanagementof cashow.Thecashbookenables
thebusinesstohavefullcontroloftheowofcash.
2. It reduces entries in other ledger books if the cash account and
bank accounts are kept together with other accounts in a ledger
book, the ledger book becomes very bulky.
3. It facilitates division of labour. It enables the business to divide
Specic objectives
By the end of the topic, the learner should be able to:
(a) Explain the meaning and purpose of a cash book;
(b) Distinguish between the basic types of a cash books;
(c) Explain the term contract entry;
(d) Prepare the various cash books.
The Cash Book
171
work among the employees where the transactions are many. One person can
specialise in maintaining the cash book while other employees would be in charge
of other ledgers.
4. The cash book provides information about receipts and payments in cash and by
cheque. This enhances making of decisions in the business.
5. It provides information about the people and businesses that pay and receive cash
fromthebusiness.Thismakesiteasiertocontrolthenancesofthebusiness.
Basic types of cash books
Depending on the size and nature of a business organisation, there are three types of cash
books commonly used. These are:
1. The single column cash book
2. The two column cash book
3. The three column cash book
1. The single column cash book
This is a cash book that has one amounts column kept by business that dont have a large
volume of transactions.
Dr. Title
Date Details Folio Amount Date Details Folio Amount
2. Two column cash book
It is a cash book that contains two amounts columns. One column shows bank
transaction while the other shows cash transaction.
DEBIT SIDE CASH BOOK CREDIT SIDE
Date
Particulars
(Details)
Folio
Cash
Ksh.
Bank
Ksh
Date
Particulars
(Details)
Folio
Cash
Ksh.
Bank
Ksh
Example:
The following transactions took place in the month of March, 2016 in Jishinde Retailers.
Mar 1: The business had Sh. 12,000 cash in hand and Sh. 35,000 cash at bank.
Mar 2: Sold a piece of old furniture for Sh. 8,000 in cash.
Mar 3: Sold goods for Sh. 10,000 receiving the money by cheque.
Mar 4: Deposited Sh. 18,000 in the bank from oce cash.
Mar 7: The proprietor took Sh. 1,500 in cash for personal use.
Mar 10: Withdrew Sh. 5,000 from the bank for oce use.
172
Mar 15: Bought goods for Sh. 25,000 and paid partly by cheque Sh. 20,000 and in cash
Sh. 5,000.
Mar 20: Withdrew Sh. 1,500 by cheque for personal use.
Mar 25: Bought stationery for cash Sh. 400.
Mar 26: Received Sh. 4,000 in cash from C. Joan.
Mar 28: Received Sh. 6,000 by cheque from J. Buyuka.
Mar 31: Paid rent by cheque Sh. 1,200.
Required:
(a) Enter the above transactions in a cash account and bank account.
(b) Enter the same transactions in a two-column cash book.
DR. CASH ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Sh.
Date
2016
Particulars/Details Amount
Sh.
Mar 1 Balance b/d 12,000 Mar 4 Bank 18,000
Mar 2 Furniture 8,000 Mar 7 Drawings 1,500
Mar 10 Bank 5,000 Mar 15 Purchases 5,000
Mar 26 C. Joan 4,000 Mar 25 Stationery 400
Mar 31 Balance c/d 4,100
29,000 29,000
Apr 1 Balance b/d 4,100
DR. BANK ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Mar 1 Balance b/d 35,000 Mar 10 Cash 5,000
Mar 3 Sales 10,000 Mar 15 Purchases 20,000
Mar 4 Cash 18,000 Mar 20 Drawings 1,500
Mar 28 J. Buyuka 6,000 Mar 31 Rent 1,200
Mar 31 Balance c/d 41,300
69,000 69,000
Apr 1 Balance b/d 41,300
173
From the entries made in the cash book above, notice that:
(i) On 4
th
March, 2016, Sh. 18,000 was deposited in the bank from the cash in hand
and the resulting entries are:
Debit bank Sh. 18,000
Credit cash Sh. 18,000
(ii) On 10
th
March, 2016 Sh. 5,000 was withdrawn from the bank for oce use and
the resulting entries are:
Debit cash Sh. 5,000
Credit bank Sh. 5,000
Contra entry
In both of these cases it will be noted that the double entries have been completed
within the cash book. When a double entry is completed within the cash book, it is
referred to as a contra entry. To identify this kind of entry in the cash book, the leer
“C” is wrien in the folio column against the entry. Thus, a contra entry is an entry
whereby, the double entry arising from a transaction is completed within the cash
book. This is in contrast with all other entries in the cash book where the corresponding
double entry will be made in other accounts in the general ledger.
The question of bank overdraft
Although the bank account is an asset account, it can have a credit balance, causing it to
become a liability. This happens when the proprietor withdraws more money from the
business bank account than the actual amount deposited. With special arrangements, a
bank can allow a customer to withdraw more money than there is in his or her account
with the bank. Such money is common with businesses. Banks charge interest on overdraft
since they are actually a form of loan to the bank customer. In this way banks also make
prot from the overdrafts allowed to their customers. The following example illustrates
how an overdraft is treated in the cash book:
DR. CASH BOOK CR.
Date
2016
Particulars
(Details)
Cash
Ksh.
Bank
Ksh.
Date
2016
Particulars
(Details)
Cash
Ksh..
Bank
Ksh.
Mar 1 Balance b/d 12,000 35,000 Mar 4 Bank C 18,000
Mar 2 Furniture 8,000 Mar 7 Drawings 1,500
Mar 3 Sales 10,000 Mar 10 Cash C 5,000
Mar 4 Cash C 18,000 Mar 15 Purchases 5,000 20,000
Mar 10 Bank C 5,000 Mar 20 Drawings 1,500
Mar 26 C. Joan 4,000 Mar 25 Stationery 400
Mar 28 J. Buyuka 6,000 Mar 31 Rent 1,200
Mar 31 Balance c/d 4,100 41,300
29,000 69,000 29,000 69,000
Apr 1 Balance b/d 4,100 41,300
174
Example:
On 1 July, 2016, Kamau Traders had Sh. 5,400 cash in hand and a bank overdraft of Sh.
15,000. During the month, the following transactions took place:
Jul 3: Received a cheque from R. Kimani for Sh. 18,000.
Jul 4: Paid rent in cash Sh. 3,500.
Jul 10: Withdrew Sh. 9,000 from the bank for oce use.
Jul 15: Sold goods for cash Sh. 10,000.
Jul 19: Purchased oce equipment, paying in cash Sh. 5,000 and by cheque
Sh. 20,000.
Jul 25: Bought oce stationery in cash Sh. 1,000.
Jul 28: Sold goods, receiving payment by cheque Sh. 21,000.
Jul 31: Paid salaries in cash Sh. 2,000.
Ex er cise 10.1
DR. CASH BOOK CR.
Date
2016
Particulars
(Details)
Cash
Ksh.
Bank
Ksh.
Date
2016
Particulars
(Details)
Cash
Ksh.
Bank
Ksh.
.
Jul 1 Balance b/d 5,400 Jul 1 Balance b/d 15,000
Jul 3 R. Kimani 18,000 Jul 4 Rent 3,500
Jul 10 Bank 5,000 Jul 10 Cash 9,000
Jul 15 Sales 10,000 Jul 19 Oce
Jul 28 Sales 21,000 Equipment 5,000 20,000
Jul 31 Balance c/d 5,000 Jul 25 Stationery 1,000
Jul 31 Salaries 2,000
Jul 31 Balance c/d 8,900
20,400 44,000 20,400 44,000
Aug 1 Balance b/d 8,900 Aug 1 Balance b/d 5,000
Exercise 10.1
1. J. Chitwa started a business on 1 August, 2016. The following transactions relate to
the business for the month of August, 2016. Enter the transactions in her cash book
and balance the cash book as at 31 August, 2016.
Aug 1: Started business with Sh. 1,600 in cash and Sh. 12,000 in the bank.
Aug 2: Paid rent Sh. 600 in cash.
Aug 3: Paid Pop Corn Suppliers Ltd. Sh. 1,600 by cheque.
Aug 4: Purchased business equipment and paid by cheque Sh. 9,000.
Aug 6: Received Sh. 2,000 by cheque from Johnson Brothers.
Aug 7: Cash sales amounted to Sh. 1,500.
Aug 10: Paid J. Gerald in cash Sh. 1,800.
175
Aug 15: Cash sales paid directly into the bank Sh. 10,000.
Aug 20: Borrowed from Boom Finance Company a loan of Sh. 6,000 which she
received by cheque.
Aug 25: Withdrew from the bank Sh. 2,000 for business use.
Aug 26: Paid rates by cheque Sh. 1,500.
Aug 28: Cash sales amounted to Sh. 900.
Aug 30: Paid Sundry expenses Sh. 240 in cash.
Aug 31: Paid wages by cheque Sh. 8,000.
2. Prepare the cash book of Mamba Stationers from the information given below and
balance the cash book as at 31
st
January, 2016.
2016
Jan 1:Commenced business with capital in cash Sh. 25,000.
Jan 2:Paid Sh. 10,000 of the cash in hand into a business bank account.
Jan 3:Paid rent in cash Sh. 1,200.
Jan 5:J. Ndungu lent the business Sh. 40,000 by cheque.
Jan 8:Paid T. Wasike by cheque Sh. 6,420.
Jan 10: Cash sales paid directly into bank Sh. 11,960.
Jan 18: K. Patel paid in cash Sh. 14,240.
Jan 20: Bought a delivery motor cycle for Sh. 29,500 paid by cheque.
Jan 23; Paid motor cycle expenses in cash Sh. 9,900.
Jan 24: Paid into the bank Sh. 16,000 in cash.
Jan26: RepaidtherstinstallmentoftheloanSh.10,000bycheque.
Jan 28: Cash sales amounted to Sh. 2,900.
Jan 31: Paid wages in cash Sh. 3,700.
3. Prepare a two-column cash book from the details below and balance it off at the
end of the month.
2016
May 1: Balances brought down from April, 2016 cash in hand Sh. 2,880 Dr. Cash
at bank Sh. 36,900 Cr.
May 2: Paid insurance by cheque sh. 2,140.
May 4: Paid telephone bill by cheque Sh. 1,330.
May 6: Cash sales Sh. 7,980.
May 8: Cash paid into bank Sh. 7,000.
May 10: Paid C. Kuria by cheque Sh. 10,920.
May 12: Paid J. Juma in cash Sh. 1,220.
May 14: Cash drawings by the proprietor Sh. 1,500.
May 15: K. Mwalimu paid by cheque Sh. 4,000.
May 20: Withdrew from the bank Sh. 4,000 for business use.
176
May 22: Cash sales Sh. 4,700.
May 24: C. Abonyo paid Sh. 3,600 in cash.
May 28: Paid rent Sh. 7,000 in cash.
4. Prepare a two-column cash book from the following information and balance it off
at the end of the month.
2004
Apr 1: Balances brought down:
Cash Sh. 8,550
Bank Sh. 14,120
Apr 2: Cash sales Sh. 8,004
Apr 4: Took Sh. 10,500 from the cash till and paid into business bank account.
Apr 5: Paid Emukasa Retail Shop by cheque Sh. 14,500.
Apr 10: Received an over-payment insurance refund of Sh. 2,700 by cheque.
Apr 15: Withdrew Sh. 4,000 from the bank for business use.
Apr 19: Paid wages by cheque Sh. 7,500.
Apr 21: Paid motor vehicle expenses by cheque Sh. 5,880.
Apr 25: Paid T. Oloo by cheque Sh. 10,000.
Apr 27: P aid general expenses in cash sh. 900.
Apr 30: Cash sales paid into bank directly Sh. 10,000.
Cash Discount
In Form I Business Studies, we learnt more about cash discounts. A cash discount was
dened as an allowance given to a credit customer for paying or seling the debt or
amount of money owing promptly. This means that the trader or supplier of the goods
or services is willing to accept a lower sum of money as full selements of the debt
owed.
To the supplier, the cash discount allowed represents money that is irrecoverable
and therefore a loss or expense. It represents the money that the seller must fore-go
in order to receive payment for goods or services supplied promptly. On the other
hand, the customer who pays promptly and receives a cash discount gains. The cash
discount received represents money that the customer gains by being relieved from
paying the money. Thus, to the seller cash discounts is a loss and therefore an expense.
It is known as Discounts Allowed. However, to the buyer cash discount is a gain and
therefore a revenue. It is referred to as Discounts Received.
The rate of cash discount allowed is usually quoted or given as a percentage of
the total sum owing. This information is given on the invoice relating to the goods or
services sold on credit.
Recording cash discounts in the books of account
When a business seles a debt and receives a cash discount, the discount received will
be recorded in a Discount Received account. Since the discount received is a gain, and
177
hence a revenue, the Discount Received account is therefore credited with the amount
of cash discount received, while the debit entry is made in the suppliers (i.e. the
creditor’s) account. The example given below illustrates how transactions involving
cash discounts received are entered in the ledger accounts.
Example:
DR. DISCOUNT RECEIVED ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh..
Date
2016
Particulars/Details Amount
Ksh.
Jan 5 Central Distributors 1,000
DR. BANK ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 5 Central Distributors 9,000
DR. CENTRAL DISTRIBUTORS ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
Jan 5 Bank 9,000
Jan 5 Discount Received 1,000
(i) Debit the liability creditor-
Central Distributors
Sh. 10,000
(ii) Credit the asset cash at
bank a/c Sh. 9000
(iii) Credit the revenue
account Sh. 1,000
Transaction Effect Entries to be
made in the ledger
On 5 January, 2016
paid Central
Distributors
Sh. 10,000 by cheque
less10%cash
discount.
(i) Decrease in liability,
creditor-Central
Distributors
Sh. 10,000
(ii) Decrease in asset cash
at bank Sh. 9,000
(iii) Increase in revenue
discounts received
Sh. 1000
178
When a business receives payment from a debtor who is a credit customer, and allows
the customer a cash discount, the discount allowed will be recorded in the Discount
Allowed account. Since a discount allowed is a loss and therefore an expense, the
Discount Allowed account will be debited with the amount of discount allowed while the
debtor’s (customer’s) account will be credited. The example given below illustrates how
transactions involving discounts allowed are entered in the ledger accounts.
Example:
(i) Debit the asset cash at bank
account Sh. 9,500
(ii) Debit the expense discount
allowed account Sh. 500
(iii) Credit the asset debtors,
L. Ochomo account
Sh. 10,000
Transaction Effect Entries to be made
in the ledger
10
th
May, 2016
received a cheque
from L. Ochomo for
Sh.10,000less5%
cash discount
allowed.
(i) Increase in asset cash at
bank Sh. 9,500
(ii) Increase in expense
Discount Allowed
Sh. 500
(iii) Decrease in asset
debtors, l. Ochomo Sh.
10,000
DR. CASH AT BANK ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
May 10 L. Ochomo 9,500
DR. L. OCHOMO ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
May 10 Bank 9,500
May 10 Discounts allowed 500
DR. DISCOUNTS ALLOWED ACCOUNT CR.
Date
2016
Particulars/Details
Amount
Ksh.
Date
2016
Particulars/Details Amount
Ksh.
May 10 L. Ochomo 500
179
This is an allowance given to a credit customer for paying or settling the debt or the
amount of money owing promptly.
Cash discount is dierent from trade discount which is only given to traders. It is
also dierent from quantity discount which is given to encourage bulk purchases.
Examples on how to calculate cash discount.
180
3. The three-column cash book
This is a cash book that included the column for discounts received by the business and
discounts allowed by the business when the business pays the suppliers promptly, it will
receive discounts and there are recorded on the credit side of the three column cash book.
On the other hand when the business allows its debtors cash discount, the amount allowed
should be recorded on the debit side.
The three column cashbook therefore is as follows
Structure of a three column cash book.
Example:
Luanda Provision Store had the following balances on 1
st
May, 2016.
Cash Sh. 2,900
Bank Sh. 65,400
Debtors: Creditors:
K. Ochola Sh. 12,000 T. Oloo Sh. 6,000
S. Ayako Sh. 28,000 Kairo Distributors Sh. 44,000
J. Mango Sh. 4,000 Makori Investments Sh. 10,000
During the month, the following transactions took place:
May 2: K. Ochola paid his account by cheque less 2.5% cash discount.
May 3: Paid Makori Investments their account by cheque less 5% cash discount.
May 8: Withdrew Sh. 10,000 cash from the bank for business use.
May 11: S. Ayako seled her account by cheque less 2.5% cash discount.
May 15: Paid wages in cash Sh. 9,000.
May 20: J. Mango paid his account in cash deducting 2.5% cash discount.
May 25: Bought furniture and ings and paid by cheque Sh. 25,000.
May 28: Cash sales Sh. 25,000.
May 29: Deposited Sh. 25,000 from the cash till into the business bank account.
May 29: Paid T. Oloo in cash, less a cash discount of 5%.
May 30: Paid Kairo Distributors by cheque less 5% cash discount.
Required:
(a) Post the above transaction to a three column cash book.
Date Particulars
(Details)
Folio
Discounts
Allowed
Sh.
Date Particulars
(Details)
Folio Discounts
Received
Sh.
Bank
Sh.
Cash
Sh.
Cash
Sh.
Bank
Sh.
DR. THREE COLUMN CASH BOOK CR.
181
Cash
Ksh.
Bank
Ksh.
Discount
received
Ksh.
Cash
Ksh
Folio
Date
Particulars
Folio
Discount
allowed
Ksh.
Bank
Ksh
May 1 Balance b/d 2,900 65,400 May 3 Makori
Investments PL 3 500 9,500
May 2 K. Ochola SL1 300 11,700 May 8 Cash C 10,000
May 8 Bank C 10,000 May 15 Wages GL 1 9,200
May 11 S. Ayako SL 2 700 27,300 May 25 Furniture
        andttingsGL2   25,000
May 29 J Mango SL 3 100 3,900 May 29 Bank C 25,000
May 28 Sales GL 3 25,000 May 29 T. Oloo PL 1 300 5,700
May 29 Cash C 25,000 May 30 Kairo
Distributors PL 2 2,200 41,800
May 31 Balance c/d 1,900 43,100
1,100 41,800 129,400 3,000 41,800 129,400
Jun 1 Balance b/d GL 4 1,900 43,100 GL 5
Date
Particulars
DR. A THREE COLUMN CASH BOOK CR
182
Exercise 10.2
1. The information given below was obtained from the business records of Anyole
Provision Store for the month of March, 2016.
Mar 1: Started business with Sh. 60,000 cash in hand.
Mar 2: Deposited Sh. 50,000 of cash in hand in a business bank account.
Mar 3: Bought furniture by cheque Sh. 9,500.
Mar 5: Bought goods and paid by cheque Sh. 12,400.
Mar 6: Sold goods for cash Sh. 4,070.
Mar 7: Paid rent Sh. 2,000 in cash.
Mar 10: T. Ngari paid by cheque Sh. 2,100 as full settlement of his account of Sh.
2,200.
Mar11: PaidM.ShahStoresbychequetheiraccountofSh.10,000lessa5%
cash discount.
Mar 12: Received a cheque of Sh. 3,800 from J. Mbogho, who had deducted her
cash discount of Sh. 200.
Mar 15: Paid rates by cheque Sh. 4,100.
Mar 20: Paid F. Nzibo his account of Sh. 1,200 in cash after deducting a cash
discount of Sh. 60.
Mar 25: Cash sales amounted to Sh. 8,800.
Mar 26: Deposited cash Sh. 8,000 into the bank account from cash in hand.
Mar29: WithdrewSh.5,000fromthebankforofceuse.
Mar 31: Paid wages in cash Sh. 4,000
Required:
(a) Prepare the three column cash book of Anyole Provision Stores.
(b) Post the total discounts to their respective discount accounts in the general
ledger.
2. Prepare a three column cash book from the information given below.
2017:
Feb 1: Balances brought forward:
Cash Sh. 1,600.
Bank overdraft Sh. 12,800.
Feb 2: Cash sales Sh. 1,360.
Feb 3: Received cheque from T. Mwaura for Sh. 1,800 who had deducted a
cash discount of Sh. 200.
Feb 9: F. Makau, a debtor, settled her account of Sh. 9,000 by cheque, less a
 cashdiscountof 5%.
Feb10: Paidchequetothefollowingcreditors,deductingacashdiscountof5%
in each case:
M. Olive Sh. 12,000; Park Road Supplies Sh. 3,000 and R.V. Patel
Sh. 16,000.
183
Feb 12: Cash sales Sh. 18,400.
Feb13: CashpaidintothebankSh.19,000incashfromtheofce.
Feb 15: A. Mwanaisha paid her account of Sh. 10,000 in cash less a discount of
5%.
Feb 20: Cash sales paid directly into bank Sh. 18,000.
Feb 25: Paid insurance in cash Sh. 8,000.
Feb 26: Cash sales Sh. 12,400.
Feb 27: Deposited Sh. 12,400 from the cash sales into the bank account.
Feb 28: Paid wages by cheque Sh. 6,800.
3. Kibicho Retail Shop had cash balance of Sh. 2,110 and bank balance of
Sh. 39,840 on 1
st
May, 2016. The following transactions took place during the
month:
May 1: Paid the following accounts by cheque less a discount of 5% in each
case:
Abdulla Stores Sh. 8,000.
Loketo Distributors Sh. 12,600,
Mwadzama Suppliers Sh. 14,400.
May 2: Received a cheque for Sh. 9,750 from J. Nafula in full selement of
her account of Sh. 10,000.
May 4: Cash sales paid directly into bank Sh. 4,900.
May 6: Paid insurance by cash Sh. 1,650.
May 9: The following debtors seled their accounts by cheque at a cash
discount of 2.5% in each case:
Lukenya School Sh. 16,000
T. Ochola sh. 6,400
Kilingali School Sh. 26,000.
May12: WithdrewSh.5,000fromthebankforofceuse.
May 13: Paid motor expenses in cash Sh. 1,500.
May 15: Cash sales Sh. 9,800.
May 20: The proprietor made drawings in cash Sh. 4,000.
May 22: Paid salaries by cheque Sh. 12,000.
May 28: Paid rent in cash sh. 2,600.
May 29: Cash sales Sh. 8,500.
May 30: Cash paid into bank Sh. 10,000.
May 31: Paid for stationery by cheque Sh. 2,700.
Required:
(a) Prepare a three-column cash book and balance it as at 31
st
May, 2016 from the
above transactions.
184
Revision Questions
1. Denethetermcashbook.
2. State why a cash book is also referred to as a subsidiary ledger.
3. Highlight the advantages of maintaining a three column cash book in a business.
4. State the implication of a credit balance in the bank column of a cash book.
5. Explain the meaning of the term, contra entry, in relation to entries in a cash book.
6. J. Mwenesi started a small scale business, dealing in vegetables with capital of
Sh. 50,000 in cash, on 1
st
July, 2016. During the month of July, 2016, the following
transactions took place:
July 2: Opened a business bank account and deposited Sh. 30,000 into the
account.
July 3: Bought furniture, paying by cheque Sh. 18,250.
July 5 : Bought stock of vegetables for Sh. 15,000 in cash, and also paid Sh. 650
in cash for carriage of the vegetables.
July 6: Bought wrapping materials for Sh. 2,000 in cash.
July 7: Cash sales amounted to Sh. 12, 700.
July 8: Deposited Sh. 12,000 into the business bank account from the cash
sales of the previous day.
July 10: Bought more stock and paid by cheque Sh. 15,000 and also paid for
carriage of the vegetables Sh. 700 in cash.
July 15: Cash sales amounted to Sh. 11,560, out of which wages Sh. 2,500
were paid and the rest was deposited in the bank account.
July 16: Withdrew Sh. 2,970 from the business bank account for personal use.
July 20: Withdrew Sh. 1,920 from the business bank account and used the money
to pay the business electricity bill.
July23: WithdrewSh.5,000fromthebusinessbankaccountforofceuse.
July 25: Paid sundry expenses in cash Sh. 2,900.
July 28: Paid wages in cash Sh. 2,500.
July 30: Increased capital by a cheque of Sh. 25,000.
(a) Enter the transactions in the general ledger and in the cash book.
(b) Balance the accounts including the cash books and prepare the trial balance
as at 31
st
July, 2016.
7. B. Ayieta is a small scale retailer who has not been keeping a cash book. The
available records reveal the following information about cash transactions in the
business for the month of May, 2016.
(i) Total sales paid by the cheque Sh. 20,000.
(ii) Total cash used to buy goods for sale Sh. 12,500.
(iii) Total transfers from the bank to cash amounted to Sh. 25,000.
(iv) Total expenses paid in cash was Sh. 12,000.
(v) Total cash sales was Sh. 13,400.
185
(vi) Total purchases paid for by cheque Sh. 20,250.
(vii) Total transfers from cash to bank amounted to Sh. 13,000.
(viii) Total creditors paid by cheque Sh. 15,000.
(ix) Total receipts from debtors by cheque Sh. 16,500.
(x) Total amount of money used for personal needs by the proprietor was
Sh. 16,000 of which Sh. 5,000 was in cash and the rest by cheque.
(xi) The balances as at 31
st
May, 2016 were, Sh. 2,100 in cash and Sh. 14,000 at
bank.
Prepare the summarised cash book of the business duly balanced as at 31
st
May, 2016.
REASONS
NAME OF
BUSINESS
TYPES OF CASH BOOKS
OTHER
FORMS OF
RECORDS
NO CASH
RECORD
SINGLE
COLUMN
TWO
COLUMN
THREE
COLUMN
KEPT