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;

(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.

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.

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.

(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.

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.

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

Price (P) (Ksh)

Quantity demanded (Q) (kg)

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.

0 10 20 30 40 50

Price (P) (Ksh)

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.

(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)

Movement

along a

demand

curve

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

the quantity demanded increases from OQ to OQ

hence the downward movement along the demand curve as illustrated by AB. If the price

increases from OP to OP

, the quantity demanded decreases from OQ to OQ

; hence the

upward movement along the demand curve as illustrated by AC.

(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)

Fig 1.7: Shift in a demand curve.

A shift from DD to D

, 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

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.

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)

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.

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.

(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.

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.

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)

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.

(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)

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.

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

, the quantity supplied increases from

OQ to OQ

. Hence the upward movement along the supply curve as indicated by

AB. When the price decreases from OP to OP

, the quantity supplied decreases from

OQ to OQ

. 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)

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

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.

Quantity supplied(Q) (kg)

Price (P) (Kshs)

Fig 1.12: Shift in a supply curve.

A shift of the supply curve from SS to S

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.

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.

100 200 300 400 500 600 700 800

Price per kilogram (P)

Quantity demanded and supplied

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.

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)

Quantity demanded and supplied (Q) (kg)

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.

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.

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.

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

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

. will have the

following eects on the equilibrium price and quantity.

(i) Equilibrium point shifts upwards to right from E to E

(ii) The equilibrium price increases from P

to P

(iii) Equilibrium quantity increases from Q

to Q

A shift of the demand curve to the left from DD to D

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

(ii) Equilibrium price decreases from P

to P

(ii) Equilibrium quantity decreases from Q

to Q

Quantity demanded and supplied (Q) (kg)

Price (P) (Kshs)

Fig 1.15: Eects of shift in a demand curve on equilibrium price and equilibrium quantity.

(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

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

(ii) Equilibrium price decreases downwards from P

to P

(iii) Equilibrium quantity increases from Q

to Q

A shift of the supply curve to the left from SS to S

has the following eects on

equilibrium price and equilibrium quantity.

(i) Equilibrium point shifts upwards to the left from E to E

(ii) Equilibrium price increases from P

to P

(iii) Equilibrium quantity decreases from Q

to Q

Quantity demanded and supplied (Q) (kg)

Price (P) (Kshs)

Fig 1.16: Eects of shift in a supply curve on equilibrium price and equilibrium quantity.

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

followed with a shift of the supply curve

from SS to S

has the following effects:

(i) Equilibrium point shifts upwards to the left from E to E

(ii) Equilibrium price P

increases from P

to P

(iii) Equilibrium quantity Q increases from Q

to Q

Quantity demanded and supplied (Q) (kg)

Price (P) (Kshs)

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

followed by a shift of the supply curve from

SS to S

has the following effects.

(i) Equilibrium points shifts from E to E

(ii) Equilibrium price P

decreases to P

(iii) Equilibrium quantity increases from Q

to Q

also reduces

When supply decreases and demand also reduces. A shift of the demand curve from DD

to D

followed by a shift of the supply curve from SS to S

has the following effects:

(i) Equilibrium price remains unchanged at Pe.

(ii) Equilibrium quantity shifts to the left from E to E

(iii) Equilibrium quantity decreases from Q

to Q

Quantity demanded and supplied (Q) (kg)

Price (P) (Kshs)

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)

(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.

(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.

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.

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.

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

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.

(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.

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.

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.

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

(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.

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.

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.

(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.

(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.

(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:

(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.

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.

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,

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..

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.

(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

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.

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:

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.

(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.

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.

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.

(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.

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.

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

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;

Product Markets

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

(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.

(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.

(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.

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

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.

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

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?

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.

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;

chain;

(d) Discussthefactorswhichmayinuencechoiceof 

a distribution channel.

Chain of

Distribution

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.

(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.

(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.

(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.

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.

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.

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

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.

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

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.

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

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.

(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.

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.

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

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;

(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

(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.

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.

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.

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:

(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.

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

(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

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

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:

(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.

(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.

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.

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.

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.

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.

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;

unemployment;

(d) Discuss the various types and causes of unemployment;

(e) Discuss measures that may be taken to solve

unemployment problems.

Population and

Employment

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.

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.

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.

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

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.

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.

(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.

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.

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.

(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.

(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.

(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.

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.

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;

(d) Relate the accounting equation to the balance sheet;

(e) Explain the meaning of net worth of a business.

Net Worth of a

Business

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.

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

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:

LIABILITIESKsh.

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

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

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

(d) 20,500 17,620

(e) 46,900 62,600

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

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

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

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.

BARAKA PROVISION STORE

BALANCE SHEET

AS AT 31

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.

BARAKA PROVISION STORE

BALANCE SHEET

AS AT 31

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

BARAKA PROVISION STORE

BALANCE SHEET AS AT

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

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

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

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

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

May, 2016 using the vertical

format.

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.

(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

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.

VYEMA ENTERPRISES

BALANCE SHEET, AS AT 30

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

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

July, 2016 and 5

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

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

JUNE 2009

101

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;

(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

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

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

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

January 2016 after this transactions will appear as follows:

BARAKA ENTERPRISES

BALANCE SHEET

AS AT 2

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

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

January 2016 will appear as follows:

BARAKA ENTERPRISES

BALANCE SHEET

AS AT 5

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

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

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

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

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

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

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

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

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

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

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

January, 2016 after this transaction will appear as follows:

BARAKA ENTERPRISES

BALANCE SHEET

AS AT 9

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

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

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.

(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

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.

(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

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

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

May, 2015 would appear as follows:

On 3

May, 2015, Mary Nabwera also contributed her personal car worth Sh.250,000 to

Mary Nabwera hair salon

Balance sheet

as at 2

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

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

February, 2015 would appear as follows;

MARY NABWERA HAIR SALON

BALANCE SHEET

AS AT 3

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

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

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

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

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

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

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

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

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

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

June 2015 for sh. 8,500, thus, making a loss of Sh.

1,500. The balance sheet of his business as at 5

June, 2015 after the transaction

MWATELA FASHIONS

BALANCE SHEET

AS AT 2

JUNE, 2015

ASSETS LIABILITIES

Sh. Sh.

Cash 20,000 Capital 20,000

20,000 20,000

MWATELA FASHIONS

BALANCE SHEET

AS AT 5

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

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

FEBRUARY, 2016

ASSETS LIABILITIES

Ksh. 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

March, 2015 showed an initial

capital of Sh. 85,000. At 31

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

April,

2015 to 31

December, 2015.

Required:

Calculate the nal capital of the business as at 31

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

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

January, 2016.

(b) Calculate the nal capital as at 31

December, 2016.

115

KIMALAT PROVISION STORE

BALANCE SHEET AS AT 31

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.

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?

(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

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

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

January, 2016.

118

TRANSACTION

(a) A debtor paid the amount

owing by cheque.

(b) Bought a business machine

on credit.

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

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

January, 2016 after the

above transactions.

7. The balance sheet of Tamu Tamu Enterprise as at 1

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

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

JANUARY 2015

120

CHARAA ENTERPRISES

BALANCE SHEET

AS AT 7

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.

(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

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;

(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.

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

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

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

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

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.

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

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.

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.

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

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

January, 2016.

(b) Open the ledger accounts of the business as at 1

January, 2016.

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

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

March, 2016.

(b) Record the above transactions in the ledger accounts of the business.

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

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

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:

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

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

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.

(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

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.

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.

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

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

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

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

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

60000

30000

Jan 3

Jan 5

Jan 9

Furniture

Weights and

measurement.

Balance c\d

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.

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

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

(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

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

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

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

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

May, 2016.

5. On 1

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

September, 2016.

(b) Open the ledger accounts of the business as at 1

September, 2016.

as at 30

September, 2016.

(d) Prepare the trial balance of the business as at 30

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.

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.

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.

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

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

(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

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.

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.

(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.

4. Use the bank account transactions given on below to answer the following

questions.

(a) Balance the account as at 31

May, 2016.

(b) Explain the transaction that took place from 3

May to 30

May, 2016.

May to 30

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

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

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

July, 2016.

(b) Open the relevant ledger accounts as at 1

July, 2016.

accounts as at 31

July, 2016.

(d) Prepare the trial balance of the business as at 31

July 2016.

170

1010

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;

(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

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

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.

Exercise 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

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: Paid 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

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

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

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

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

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

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

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

May, 2016.

REASONS

NAME OF

BUSINESS

TYPES OF CASH BOOKS

OTHER

FORMS OF

RECORDS

NO CASH

RECORD

SINGLE

COLUMN

TWO

COLUMN

THREE

COLUMN

KEPT