MASINDE MULIRO UNIVERSITY OF SCIENCE AND TECHNOLOGY

SCHOOL BASED PROGRAMME

ESM 104: QUANTITATIVE SKILLS II

FACULTY OF EDUCATION AND SOCIAL SCIENCES

DEPARTMENT OF SCIENCE AND MATHEMATICS EDUCATION

(COVER PAGE)

KAFUCO ESM104 GOOD MOMS

MASINDE MULIRO UNIVERSITY OF SCIENCE AND TECHNOLOGY

SCHOOL BASED PROGRAMME

ESM 1O4: QUANTITATIVE SKILLS II

FACULTY OF EDUCATION AND SOCIAL SCIENCES

DEPARTMENT OF SCIENCE AND MATHEMATICS EDUCATION

KAFUCO ESM104 GOOD MOMS

 Copyright © MASINDE MULIRO UNIVERSITY 2012

All Rights Reserved

Published By:

DIRECTORATE OF PUBLIC COMMUNICATIONS AND PUBLISHING

MASINDE MULIRO UNIVERSITY OF SCIENCE AND TECHNOLOGY

KAFUCO ESM104 GOOD MOMS

 Table of Contents

KAFUCO ESM104 GOOD MOMS

 Comments from the Users

Dear Learner,

This is the First edition of this module. We are committed to improving future issues in order to
fulfill the users’ needs. For this purpose we encourage you to feel free to provide us with
constructive comments and observations.

Please use evaluation form attached at the end of the module.

We look forward to receiving your feedback.

KAFUCO ESM104 GOOD MOMS

 Symbols Used in the Module

THE FOLLOWING SYMBOLS HAVE BEEN USED IN THE MODULE

INTRODUCTION (used only for module introduction)

TABLE OF CONTENTS (used once)

OBJECTIVES (used in module and Topic objectives)

SECTIONS (used just once in each Topic at the beginning)

SUMMARY (used once in each Topic)

ACTIVITIES (used sparingly in each Topic)

DISCUSSION (used with activity icon)

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NOTE (used throughout the text to emphasis a point)

QUESTION MARK (used throughout the module text to break monotony)

EXAMPLE (used throughout the text when giving examples)

CAUTION (used only when there is warning when using chemicals)

LEARNING OUTCOMES (used once at the end of each Topic)

CONGRATULATIONS (used once at the end of each Topic)

FURTHER READING (used once in each Topic)

SELF-CHECK (used once in each Topic)

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GLOSSARY (used once at the end of the module)

ANSWERS TO SELF-CHECK (used once at the end)

BIBLIOGRAPHY (used only once)

APP

APPENDIXES

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 COURSE OUTLINE

MASINDE MULIRO UNIVERSITY OF SCIENCE AND TECHNOLOGY

DEPARTMENT OF SCIENCE AND MATHEMATICS EDUCATION

SECOND SEMESTER COURSE

KAFUCO

ESM 104: QUANTITATIVE SKILLS II

LECTURER

METRINE SULUNGAI 0729594074

OBJECTIVES

To provide an all rounded background to future educationists, scientists and

researchers/scholars. The course intends to provide a sound mathematical background
necessary for day to day life.

1. DURATION
The course will last for one semester (16 weeks). It will consist of three lecture hours per
week

2. MODE OF TEACHING
The course shall be taught through lectures, tutorials and assignment.

3. MODE OF EXAMINATION
There will be at least two sit in Continuous Assessment Tests (CAT) constituting 30%
and one end of semester examination constituting 70%.

COURSE DESCRIPTION
Record keeping: assets, liabilities, capital, ledger, recoding transactions; Simple investment
analysis: income statement, trading, profit and loss accounts, balanced sheet; financial ratios,
Interests, discounts and commissions: simple and compound interest, calculations of discounts
and commissions; Public finance: functions of the government, public revenue and public
expenditure, balance of payments, Gross National Product (GNP), Gross Domestic Product
(GDP); Budgeting; personal budget, simple business budgets, performance budgeting; Taxation:
definition and principal types, tax evasion and calculation of personal income taxes; Index
numbers: simple determination and their uses, price indices and the concept of inflation, stock
market

Course Content

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S/N Course Content Week Hours

1 Course overview and introduction 1 3hrs

Book keeping

Definition of assets, liabilities and capital

2 Recording transactions in the ledger 2 3hrs

Trial Balance

3 Investment analysis 3-4 6hrs

Preparation of final accounts

Trading, profit and loss account

3 Balance sheet 5 3hrs

4 Financial ratios 6 2hr

5  CAT ONE 6 1hr

6 Interest, Commission and Discounts 7 3hrs

7 Public finance 8 3hrs

Functions if the government

Public revenue and expenditure

8 GDP, GNP AND BoT 9 1hr

9 Budgeting 8 2hrs

10 Taxation 9-10 4hrs

Principles of taxation

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 Tax evasion and its remedial measures

11 Income tax calculation 10-11 4hr

12  CAT TWO 11 1hr

13 Index numbers 12-13 4hrs

Introduction and examples

Uses of index numbers

Price indices

14 Stock market 14 2hrs

15 Examinations 15-16 3hrs

TOTAL HOURS 45hrs

REFERENCES

1. Deakin B.E. and Maher W.M(1987): Cost Accounting, 2nd Ed. U.S.A.

2. Ferries R. Kenneth (1993): Financial Accounting and Corporate Reporting, 3rd Ed. Irwin

3. Mullings G.F and Shao P.S (1979) Mathematics for Management and Finance gage
publishers, Canada

4. Slater R. and Curwin, J(2002):Quantitative Methods for Business Decisions, 5th Ed.
Thomson

5. Syme G.E (1997): Accounting I Prentice-hall, of Canada, Ontario.

6. Saleemi S. A. (2003) Simplified Mathematics

7. E-journals and the internet

INTRODUCTION TO THE MODULE

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 Welcome to this module for ESM 104: Quantitative Skills 2 course. This module
provides an in-depth background to aspiring educationists, scientists, researchers and scholars.
The course intends to provide a sound mathematical and business background necessary for day
to day life. Specifically, the module introduces basic concepts in book keeping and the analysis
of the performance of an investment, calculation of interests, commissions and discounts. The
course will also prepare you in preparing a variety of budgets namely: personal, business budgets
as well as the process involved in preparing national budgets. Further, the module introduces the
basic concepts in public finance, taxation and its computation; index numbers with a focus on
price indices and stock market as a way of analyzing inflation.

This Module has six major topics. Every topic has sub-topics as you will see in the Module.
Ensure that you have read and understood every topic before you proceed to the next one. In
every topic you will find symbols that give instructions on what is expected of you for example
to take a note on an important aspect; to do an activity or even to refer to other or previous
Modules. At the end of every topic there will be a self check where you are expected to assess
your understanding and to give yourself a score in order to measure your level of understanding.
It is my hope that your will enjoy reading this Module and please feel free to comment on the
whole Module.

AIM

This module aims at equipping you (the learner) with relevant quantitative techniques that are
not only useful but also necessary for day to day life experiences.

OBJECTIVES

This module is intended to help you achieve the following objectives

1. Record transactions in ledger accounts and prepare final statements

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 2. Evaluate the viability and performance of an investment

3. Calculate interests, commissions and discounts

4. Explain the concepts of public revenue and public expenditure

5. Prepare a personal and business budget and explain the process of national budgeting

6. Describe the concept of taxation and calculate the income tax of an individual

7. Justify the existence of a stock market in the country and

8. Compute the price index of commodities

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TABLE OF CONTENTS

Place here the module contents. These are the key

learning areas or expectations of the student after studying this
module.

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 TOPIC ONE

BOOK KEEPING

1.0 INTRODUCTION

This topic introduces you to the general concept of record keeping. It introduces you to the basic
tenets of recording transactions and how to summarize transactions. Further, we shall learn how
to prepare the final statements from the transaction and finally determine the viability of the
investment.

1.1 OBJECTIVES

By the end of this topic, you should be able to:

 Define basic terms used in book keeping
 Record transactions in the relevant books of accounts
 Extract a Trial balance from the books of accounts

1.2 SECTIONS OF THE TOPIC

In this topic, we shall cover the following sections:

Section 1: definition of terms
Section 2: recording transactions
Section 3: trial balance

These sections are discussed as hereunder.

1.2.1 DEFINITION OF TERMS

Before we discuss recoding transactions, let us briefly have an overview to book keeping. We
define book keeping as a systematic way of recording transactions for analysis and decision
making. In order to understand the concept of book keeping appropriately, let us define some
basic terms associated with it.

A record: This is a form of stored information which is referred to at a

later date and it used in making decisions. Records can be classified as official and non official.
Official records are those records kept by a particular organization e.g. the government,

KAFUCO ESM104 GOOD MOMS

institutions like schools or a business firm. These are usually standard in form depending on the
needs of a particular organization. Such records are standardized since they are usually used by
many people. Non official records on the other hand are those kept by individuals and may vary
from one person to another depending on the individuals taste. Such records have no standard
way of entering information but depend on the individuals interests. They are only useful to a
particular person.

In general, records serve the following purposes:

1 Records help in making decisions.
2 Records indicate efficiency and professional experience/competence. Especially at personal
level.
3 They indicate evidence of efficiency by showing the relationship between inputs and outputs
of a business firm or institution. Therefore they indicate whether improvement is essential or
not.
4 Records help in making accurate conclusions. They show or tell whether a business is credit
worthy.
5 They are used for future references and hence useful tools for research.
6 Records serve as a legal requirement especially for transaction purposes.
7 Records in a busy firm help the proprietor to be in touch with his/her business. He can spot
check the business, keeps control of costs, manage credit, debt and control business assets.

State any other reasons for keeping records?

Business records -these are records that result from business transactions. A business transaction
is any event expressed in terms of money that is related to a business and affects the assets,
liabilities and owners equity of that business. Examples of business transactions are: cash
purchases, sales, credit purchases, borrowing money, payment of expenses and withdrawal of
earnings by owners, depreciation and new investment in the business. For all business
transactions, the following equation maintains equality. Assets equals’ liabilities plus capital
(ASSETS = LIABILITIES + CAPITAL). This is known as the fundamental accounting equation.
In most financial statements, the terms: assets, liabilities and capital are used. These are defined
as hereunder.

Assets: These are all business’s possessions and rights that have money
value. They are resources which are owned by the business and are either fixed or current.

A current asset is a resource owned by a business which the business expects to consume or
convert to cash in a relatively short time (usually within a year). Examples of current assets
include cash in bank; stock in hand, debtors, accounts receivable and notes receivable.

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Accounts receivable mean that the business has given someone else goods and services for which
it is owed money by that person or that business. Similarly notes receivable mean that the
business has given someone money or credit and that the person has given the business a written
promise to pay.

Fixed assets are sometimes known as plant assets. These are assets intended to be held over a
relatively long period of time- usually more than a year by a business. They are resources owned
by a business which are expected to be consumed or converted to cash in a relatively long time.
Examples of fixed assets include premises, land, trucks, fittings and equipment. It is noteworthy
that all fixed assets except land, depreciate or loose their deported value over a period of time.
This means that a fixed asset except land is expected to loose some of its usefulness as it gets
older. In general, each fixed asset has the following characteristics:

1. It is actively used in the operation of a business.

2. It is supposed to yield service over a number of years.
3. It physically exists (tangible).
4. It is not held for re-sale but as an investment.

Assets are further classified as follows:

Intangible Assets – these are assets you cannot easily touch but they exist. These assets include
good will; copy rights and Trade marks (trade names).These intangible assets have the potential
of generating some income for a business and have the following characteristics:

1. They are either purchased or developed by a business.

2. Their ownership confers exclusive rights.
3. They provide future benefits to operation
4. They are relatively long lived.

Wasting Assets – these are those assets that are exhausted with use e.g. mines and quarries.

Fictitious Assets – these are those assets that are preliminary expenses in company e.g discount
on issue of shares, debit balance of the profits & loss accounts.

Liabilities: These are claims which are long term or current against the
business. They are debts of a business. Liabilities can be classified as either current (short term)
or long term. Current Liabilities are debts of the business which are payable in a relatively short
period of time, usually less than one year. Examples of current liabilities include accounts
payable or creditors and expenses (wages, salaries, taxes payable etc). Long term liabilities are
debts of a business that are payable in a long period of time, usually more than one year. This
includes mortgage on building or land, long term bank loans and equipment loans.

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 Capital: This is also commonly called the net worth of a business. It is the
owners claim against the assets of a business after the liabilities have been deducted. In record
keeping for a business, the business is regarded as a separate body from the proprietor. The
business is treated as a person who can borrow and rent money, pay wages, purchase supplies,
rent office space etc. capital can be classified either equity capital or loan capital. Equity capital
is the amount provided by the owners of the business and any other profits attributed to the
owners while loan capital is that amount that is borrowed by the business whose providers are
paid a fixed rate of interest and do not share the profits of the business. It is in this regard that
capital is considered as a special liability because it contributes to the owners claim to assets of
the business and also it can only be paid if the business is winding up.

1.2.2 RECORDING TRANSACTIONS

A transaction: this is any dealing in goods and services between two or

more parties for a payment. Such payments take either of the forms of immediate payment (cash
payment), immediate payment in kind (by cheque) or differed payments (payments at a later
date). It is out of these forms of payment that two types of transactions are based i.e cash
transaction derived from immediate payments and credit transactions arising from differed
payments.

Ensuing from this is the nature of transactions that has a two fold aspect i.e the giving of a value
and the receiving of the same value. This two fold nature that involves transactions and which
must be recorded in the books of accounts is called DOUBLE ENTRY.

Basically, accounting is the theory and technique of analyzing and interpreting of financial data
as well as setting up the book keeping systems. Book keeping is the systematic recording, sorting
and summarizing of business transactions (expressed in money) that affect the financial position
of a business. In general therefore, accounting lays emphasis on analysis, while book keeping is
based on the principle of double entry.

A journal: this is a book containing a chronological record of business

transactions. It is a book in which transactions are recorded originally under the double entry
system. A journal is any original book of entry. Types of journals include: Cash book, purchases
book, sales book.

The following is the general format of a journal

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DATE PARTICULARS L.F. DEBIT CREDIT

1 2 3 4 5

1. Date: - the date on which the transaction was entered.

2. Particulars:-Are the details regarding accounts which have to be debited and credited.

3. L.F.( Ledger Folio): - A reference page in the ledger. The transactions entered in the journal
are later on posted to an account in the ledger (A ledger account).

4. Debit (Dr): In this column, the amount to be debited is entered.

5. Credit (Cr):- The amount to be credited is entered.

The transactions in the journal are recorded on the basis of the rules of debit and credit.

The Ledger: this is a book where business transactions are recorded in

specific accounts. An account is a chronological record of all transactions affecting a particular
item. All transactions pertaining to a particular item are recorded on one side of an account and
all the accounts are kept in the ledger. Therefore an account is a book keeping device used to
record the increases (on one side of the account) and decreases (on the other side of the account)
of a specific type of asset, liability or capital brought about by a business transaction. Hence an
account has two sides called the debit and credit. Debit (Dr) by convention, is on the left hand
side of an account and indicates inflow of money value to an account while Credit (Cr) by
convention, is on the right hand side of the account and indicates an outflow of money value
from an account. A typical format of an account would look like this:

Name of the item (account)

Debit(Dr) Credit (Cr)

Date Particulars Amount Date Particulars Amount

Double entry book keeping is basically equalizing the resources held with the claims against an
enterprise. Whenever a transaction occurs, at least two accounts will be affected. Therefore for
every debit entry, there is a corresponding credit entry and vice versa. This means that the entry
of a debit amount in one account always accompanies a corresponding entry of a credit amount
in one or more other accounts. Thus one transaction may affect many accounts but for any one
transaction, total debits and total credits must be equal.

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 Recording transactions in the ledger: in order to record transactions in a
ledger account, it should be noted that transactions resulting in an increase in a particular item
are recorded on one side of an account while those resulting in a decrease are recorded on the
other side of an account as follows:

For assets, an increase is debited while decreases are credited

For liabilities and capital, an increase is credited while decreases are debited

For expenses i.e these are costs incurred by the business to sustain its smooth running. They are
taken as assets consumed by the business e.g stationary, electricity, salaries, rent, insurance,
discount allowed etc. therefore expenses are recorded as assets explained above.

For revenues i.e this includes incomes obtained from activities other than the normal trading
activities of the business e.g commission received, interest earned, rent received etc. such
incomes are recorded similar to liabilities and capital above.

Arising from the above discussion, there are therefore five major types of accounts found in the
ledger namely:

1. Assets account such as cash account

2. Liability accounts e.g. salaries account, wages account etc.
3. Owners equity account e.g. capital account
4. Revenue accounts such as discount received accounts, rent received account etc
5. Expenses accounts such as repairs, wages, bills accounts.

The above five types of accounts may broadly be classified into three as:

i.) Real Accounts - these represent things we can see, touch or move e.g. assets accounts.
ii.) Personal Accounts - this always contains the name of the person or business firm.
iii.) Nominal Accounts - these records transactions for which we have nothing tangible to
show e.g. expenses, profits and gains etc.

From these broad classifications we can establish definite rules of posting the information to the
ledger accounts.

1. In real accounts, we debit the receiver and credit the giver. We debit what comes in and
credit what goes out.
2. In personal accounts, we debit the receiver and credit the giver.
3. In nominal accounts, we debit the losses and expenses and we credit profits and gains or
incomes.

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 The accounting cycle: this consists of the accounting procedures from
recording transactions to preparation of financial statements. These procedures are repeated by
the book keeper during each accounting period hence comprise of an accounting cycle.
Generally, an accounting circle is based on the following.

1. Business transactions of many types are made daily.

2. The business transactions for each day are entered in the general journal.
3. The information in the general journal is transferred to a record called a ledger which has
a separate page for each account. This process is called posting.
4. An inter-summary of the balances in the ledger is prepared. This is called the trial balance
which verifies the balances in the ledger.
5. The information obtained in the trial balance is adjusted to correct the account balances in
the ledger.
6. The adjusted information resulting from the trial balance is used to prepare the income
statement and the balance sheet.

From these procedures, it is evident that book keeping follows a sequence in recording
transactions in the following order:

Journal→Ledger→Trial Balance→ Trading, Profit and Loss Account→Balance Sheet

What basic questions would you consider for you to understand

and record a transaction?

When faced with any transaction, here are some questions you may ask yourself:

1. Which two accounts are affected? You give each of them a name.
2. What types of accounts are they? You broadly classify them as real, personal or nominal.
3. Which one is to be debited and which one is to be credited? If you are certain that one is
to be debited then the other must be credited.

The following Rules of Double Entry always apply in book keeping

For Personal Accounts: Dr Receiver and Cr Giver.

For Real Accounts: Dr What comes in and Cr what goes out.

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For Nominal Accounts: Dr Expenses & Losses and Cr All gains and incomes

For Assets Accounts: A transaction that affects an increase should be debited in an assets
account. The one that affects a decrease is credited in the assets account.

For Liability and Capital Accounts: Any transaction that increases the liabilities or capital
account is credited while that which decreases the liabilities or capital is debited.

For Revenue Accounts: Decreases in revenue are credited while increases are debited.

Therefore when recording on the transactions account format the recording process becomes
simply a matter of knowing which side of the accounts should be used to record the increases
and which side to record the decreases.

Example

You are required to open the relevant ledger accounts and record the following transactions for
January 2007 in the records of C. Williams.

On Jan 1st, started Business with sh.2000 in cash.

On Jan 2nd, paid sh.1800 of the opening cash into a bank account for the business.

Jan 5th, bought office furniture on credit from Betta Built limited for sh.120.

Jan 8th, bought a motor van paying by cheque sh.950

Jan 12th, Bought wax machinery from Evans and sons on credit for sh.560.

Jan 18th, returned faulty office furniture costing sh.62 to Betta built limited.

Jan 25th, sold some of the wax machinery for sh.75 in cash.

Jan 26th, paid amount owing to Betta built limited sh.58 by cheque.

Jan 28th, took £100 out of the bank and put it in the cash.

Jan 30th, J. Smith lends us sh.500 giving us the money by cheque.

Solution

These transactions can be entered in the journal as shown below.

Date Particulars Debit (Dr) Date Particulars Credit (Cr)

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2007 sh. 2007 sh.

Jan 1st Cash a/c 2,000 Jan 1st Capital a/c 2000

Jan 2nd Cash a/c 1,800 Jan 2nd Bank a/c 1800

Jan 5th Furniture a/c 120 Jan 5th Betta Built a/c 120

Jan 8th Bank a/c 950 Jan 8 th Motor Van a/c 950

Jan12th Wax Machinery a/c 560 Jan 12 Evans& Sons a/c 560
th
Jan 18th Cash a/c 62 Furniture a/c 62
Jan 18th
Jan 25th Machinery a/c 75 Cash a/c 75
Jan 25th
Jan 26th Bank a/c 58 Betta Built a/c 58
Jan 26th
Jan 28th Bank a/c 100 Cash a/c 100
Jan 28th
Jan 30th Bank a/c 500 J. Smith a/c 500
Jan 30th

These transactions can be entered in the respective ledger accounts as below. However, there is
need to balance off the accounts. To do this we compute the debit and credit totals of the entries
and the difference in these totals. This difference is reflected as balance carried down (c/d) on the
side that is less in value. The balance is then brought down below the balancing totals and on the
opposite side of the account as the balance brought down (b/d). This balance shall be used as the
opening balance in the subsequent trading period.

Dr Cash a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

1/1/2007 Capital 2000 2/1/2007 Bank 1800

25/1/2007 Wax Machinery 75

28/1/2007 Bank 100 31/1/2007 Balance c/d 375

2175 2175

31/1/2007 Balance b/d 375

Dr Capital a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

31/1/2007 Balance c/d 2000 1/1/2007 Cash 2000

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 2000 Balance b/d 2000

31/1/2007 2000

Dr Bank a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

2/1/2007 Cash 1800 8/1/2007 Van 950

30/1/2007 J. Smith 500 26/1/2007 Betta Built Ltd. 58

28/1/2007 Cash 100

31/1/2007 Balance c/d 1192

2300 2300
31/1/2007 Balance b/d 1192

Dr Office Furniture a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

5/1/2007 Betta Built 120 18/1/2007 Betta Built 62

31/1/2007 Balance c/d 58

120 120
31/1/2007 Balance b/d 58

Dr Betta Built a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

18/1/2007 Furniture 62 5/1/2007 Furniture 120

26/1/2007 Bank 58

120 120

Dr Motor Van a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

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8/1/2007 Bank 950 31/1/2007 Balance c/d 950

950 950

31/1/2007 Balance b/d 950

Dr Wax Machinery a/c Cr

Date Particulars Amount Date Particulars Amount sh.

sh.

12/1/2007 Evans & Sons 560 25/1/2007 Cash 75

Balance c/d 485

560 560
31/1/2007 Balance b/d 485

Dr Evans & Sons a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

31/1/2007 Balance b/d 560 12/1/2007 Wax Machinery 560

560 560

31/1/2007 Balance b/d 560

Dr J. Smith a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

31/1/2007 Balance c/d 500 30/1/2007 Bank 500

500 500

31/1/2007 Balance b/d 500

1.2.3 TRIAL BALANCE

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 After balancing the ledger accounts, a trial balance is prepared. This is a
statement showing the balances of the various ledger accounts. It is thus a trial run to prove that
the debit balances equal the credit balances of the accounts. This represents proof of the equality
of both sides of the fundamental accounting equation. The trial balance is a pre-requisite to the
preparation of final statements. In preparing the trial balance, we record the balances of the
accounts in the order in which they appear in the ledger.

Generally, a trial balance is prepared for the following reasons

a) To check the arithmetic accuracy of the books of original entry.

b) To help prepare a trading, profit and loss account.
c) To enable prepare a balance sheet.
d) To know the balance of any account in the ledger easily and conveniently.

A trial balance is prepared at the end of the accounting period and as such it takes the
following format.

List of Ledger a/c titles DR CR

Assets Liabilities and capital

Expenses Revenue

Totals Xxx xxx

Example 1

Consider the example on C. WILLIAMS discussed and presented above. The following is
obtained

C. WILLIAMS TRIAL BALANCE AS AT 31ST JANUARY 2007

DR sh.( sh.) CR (sh.)

Capital a/c 2000

Cash a/c 375

Bank a/c 1192

Office Furniture a/c 58

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Motor van a/c 950

Wax Machinery a/c 485

Evans & Sons a/c 560

J. Smith a/c 500

3060 3060

Example 2

Consider the following transactions that took place in the month of May 2001

On 1st May started an engineering business putting sh.1000 into a business bank account.

On 3rd May bought wax machinery on credit from Unique Machines sh.275.

On 4th May Withdrew sh.200 from the bank and put it in cash.

On 7th May bought a Motor Van paying in cash sh.180.

On 10th May sold some of the machinery for sh.15 on credit to B. Barners.

On 21st May returned some of the machinery valued sh.27 to Unique Machines.

On 28th May B. Barness paid the firm the amount owing sh.15 by cheque.

On 30th May bought another motor van paying by cheque sh.420.

On 31st May paid the amount of sh.248 to Unique Machines by cheque.

Solution:

The journal entries will be as follows.

Debit Credit

Bank a/c Capital a/c

Machinery a/c Unique Machines a/c

Cash a/c Bank a/c

Motor Van a/c Cash a/c

B.Barness a/c Machinery a/c

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Unique Machines a/c Machinery a/c

Bank a/c B.Barness a/c

Motor Van a/c Bank a/c

Unique Machines a/c Bank a/c

The ledger accounts that will be opened and the subsequent entries shall be as follows:

Dr Bank a/c Cr

Date Particulars Amount Date Particulars Amount

sh. sh.

1/5/2001 Capital 1000 4/5/2001 Cash 200

28/5/2001 B. Barness 15 3/5/2001 Motor Van 420

31/5/2001 Unique Machine 248

31/5/2001 Balance c/d 147

1015 1015
31/5/2001 Balance b/d 147

Dr Capital a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

31/5/2001 Balance c/d 1000 1/5/2001 Bank 1000

1000 1000

31/5/2001 Balance b/d 1000

Dr Machinery a/c Cr

Date Particulars Amount Date Particulars Amount

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 sh. sh.

3/5/2001 Unique Machines 275 10/5/2001 B. Barness 15

21/5/2001 Unique Machines 27

Balance c/d 233

275 275
31/5/2001 Balance b/d 233

Dr Unique Machines a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

21/5/2001 Machinery 27 3/5/2001 Machinery 275

31/5/2001 Bank 248

275 275

Dr Cash a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

4/5/2001 Bank 200 7/5/2001 Motor Van 180

31/5/2001 Balance c/d 20

200 200
31/5/2001 Balance b/d 20

Dr Van a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

7/5/2001 Cash 180 31/5/2001 Balance c/d 600

31/5/2001 Bank 420

600 600

31/5/2001 Balance b/d 600

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Dr B. Barness a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

10/5/2001 Machinery 15 28/5/2001 Bank 15

15 15

The trial balance as at 31/5/2001

Account title Dr. (sh.) Cr. (sh.)

Bank account 147

Capital account 1000

Machinery account 233

Unique machinery account 0

Cash account 20

Motor Van account 600 . .

1000 1000

ERRORS: an error is a wrong entry in the ledger account. This arises as a

result of misposting. When such errors occur, a trial balance will not balance. However, although
a trial balance checks the arithmetic accuracy of the recordings, there are certain errors which
you may commit and fail to realize. Some of the errors which cannot be revealed by Trial
Balance are explained below.

1. Error of commission: This is where the correct amount is entered but in the wrong
persons account e.g. sales of sh 250 to B Brown entered in G Brown’s account

2. Error of omission: This is where the transaction is completely omitted from the books.

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 3. Error of principle: This is where an item is entered in the wrong class of account e.g. if a
fixed asset such as a motor vehicle is debited to an expense account such as motor
expenses.

4. Compensating error: This is where an error on the Debit side cancels another similar error
on the Credit side e.g debiting the salaries account by sh1500 instead of sh2000 and then
crediting sales by sh3500 instead of sh4000 therefore under debiting salaries account by
£500 and under crediting sales account by sh500.

5. Error of original entry: This is where the original figure is incorrect, yet double entry is
observed using this incorrect figure e. g error in the sales invoice.

6. Complete reversal of entries: This is where correct accounts are used but each item is
shown on the wrong side of the account.

These errors can be corrected in the books of accounts as follows:

The error of commission: In order to correct this type of error, you must counsel out the mis-
posting by an opposite entry.

The Error of Omission: The error of omission is corrected by simply entering the omitted
transaction in the books.

The Error of Principle: The error of principle is corrected by first counseling out the original
entry and posting the amount to the correct account.

The error of compensating: You must analyze whether you have debited or credited the
amount with too much or too little e.g. to correct an error where we have debited sh150 to the
salaries a\c instead of sh200 and credited sh350 to the sales a\c instead of sh400 the correct entry
will be to Dr Salaries by sh50 and Cr Sales by sh50

The error of reversal entry: We must reverse our original entry and post the transaction as it
has been posted in the first instance.

The error of original entry: If we have posted an amount which is less than the correct amount,
we make an additional entry for the amount difference posting the same accounts as the original
entry.

1.3 SUMMARY

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In this topic we have learnt that book keeping is a systematic recording of transactions for
purposes of analysis and interpretation. The concepts of assets, liabilities and capital were
explained and their relationship established in terms of the basic accounting equation i.e Asset =
Liabilities + Capital. Also we have learnt that all transactions pertaining to an increase in a
particular item are recorded on side of the account while those that result in a decrease are
recorded on the other side of the account as for the assets, liabilities and capital, expenses and
incomes.

Further, we learnt that after recording transactions in their respective ledger accounts, there is
need to balance them off. The closing balances are carried forward to the next trading period and
as hence shall be the opening balances of the accounts. Moreover, we have discussed that we can
check the arithmetic accuracy the recordings of the transactions by drawing up a trial balance.
This also gives the total debit and credit balances at a glance. Finally, we have learnt that there
are errors which may not be disclosed by preparing a trial balance and how they can be
corrected.

1.4 SELF CHECK

SELF CHECK 1
1. Mrs. Mwangi started a business in 1st January 2011 with a capital of sh.2000000 which she put
into the business bank account. During the month, the following transactions took place.

Jan 2nd paid for business premises by cheque worth sh.800000

Jan 4th purchased sugar from Mumias Sugar Company for sh.400000 on credit

Jan 5th sold some sugar to Mrs. Sululu for sh.240000 on credit

Jan 15th paid Mumias Sugar Company by cheque of sh.400000

Jan 19th Mrs. Sululu returned one bag of sugar worth sh.8000 and paid the balance by cash

Jan 22nd sold sugar for cash sh.120000

Jan 25th purchased more sugar from Mumias Sugar Company for sh.480000 and paid by cheque

Jan 26th sold sugar for cash worth sh.320000

Jan 30th returned sugar to Mumias Sugar Company worth sh.60000 and was paid by cash

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 a) Enter the above transactions into the ledger accounts (10 marks)

b) Extract a trial balance as31st January 2011 (5marks)

2. The following balances were extracted from Njeri Traders as at 31st December 2010: Land and
Building Kshs. 150,000, Motor vehicle Ksh. 120,000, Debtors Kshs. 15,000, Creditors Ksh
4,000, Cash Ksh 30,000 and capital Ksh 311,000. During the month of January 2011, the
following transactions took place.

Jan 1 Opened a bank account and deposited Ksh. 10,000

7 Borrowed Ksh. 100,000 from a co-operative society and deposited in the bank.

10 Bought premises at ksh. 70,000 by cheque

13 Drew Kshs. 20,000 for business use

17 Bought stock worth Ksh 15,000 on credit

19 Sold stock worth Ksh 5,000 at Kshs. 8,000 and received Ksh 6,000 in cash

21 Paid wifes bill of Ksh 3,000 in cash from the business

25 Spend Kshs 20,000 on vehicle repairs

28 Paid creditors Kshs. 10,000 by cheque.

Required:

a) Enter the above transactions into Njeri Traders books and balance them off (12 marks)
b) Extract Njeri Traders trial balance as at end of January 2011 (3 marks)

1.5 Score Board

Range of marks Level of Performance

25-30 Very good

15-24 Good

11-14 Satisfactory

0-10 Read the topic again

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 1.6 LEARNING OUTCOMES

You have now completed the topic on public finance, please tick in the column which reflect
your understanding of the various learning outcome listed below.

No. Learning Outcome Sure Not Sure

1. I can now define book keeping and its associated

concepts

2. I can open ledger accounts and record transactions

3. I can now balance off the ledger accounts

4. I can now extract a trial balance from the edger

accounts

5. I can now describe the errors that do not affect a trial

balance

If you have put a tick at the “not sure” column, please go back and study that section in the topic
before proceeding.

If you have ticked “sure” in all the rows in all the columns you are ready for the next topic

Congratulations! You can continue to the next Topic

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1.7 FURTHER READING

Deakin B.E. and Maher W.M(1987): Cost Accounting, 2nd Ed. U.S.A.

Ferries R. Kenneth (1993): Financial Accounting and Corporate Reporting, 3rd Ed. Irwin

Mullings G.F and Shao P.S (1979) Mathematics for Management and Finance gage publishers,
Canada

Slater R. and Curwin, J(2002):Quantitative Methods for Business Decisions, 5th Ed. Thomson

KAFUCO ESM104 GOOD MOMS

 TOPIC TWO

INVESTMENT ANALYSIS

2.0 INTRODUCTION

Welcome to our second topic of the module. In topic one, we discussed book keeping and
especially how to record transactions. In this topic, we are going focus on how to determine the
profitability of the business. We shall discuss how to prepare the final accounts of the business
that show the profits earned or the loss suffered. Further, we shall consider the basic ratios that
reveal the performance of the business.
2.1 OBJECTIVES

By the end of this topic, you should be able to:

 Prepare the final accounts of the business
 Compute the financial ratios of the business
 Describe the viability of the investment

2.2 SECTIONS OF THE TOPIC

In this topic, we shall cover the following sections:
Section 1: Final accounts
Section 2: Investment analysis
Section 3: Financial ratios

These sections are discussed below.

2.2.1 FINAL ACCOUNTS

The financial statements which are most important statements for internal and external use are
the income statement and the balance sheet. These financial statements are prepared to find the
profit made by a business during a trading period. These statements are known as final accounts
and they consist of the following:

The Income Statement: The income statement of a firm consists of the

trading account and the profit and loss account. These accounts provide a summary of the
accounts that will have affected the profit or loss position of the business in a particular trading
period. These are explained as hereunder.

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 1. TRADING ACCOUNT

This is a financial statement which shows the revenue from sales, cost of sales, and the gross
profit arising during the accounting period. It is used to ascertain the gross profit or gross loss of
the business.

Gross profit is the sales less cost of goods sold. It represents the difference between sales
revenue and purchase price of goods sold (Sales – Cost of goods sold). However, when the
purchase price exceeds the sales then we have a gross loss. To obtain cost of goods sold add net
purchases( purchases – purchase returns or otherwise returns outwards) and carriage inwards to
the opening stock then subtract closing stock at the end of the period

Example

At 31st Dec. 2006, Kamau’s accounts disclosed the following balances: Purchases 25,000.00,
Sales 35,000.00, Stock at 1st Jan. 2006 as 5,000.00 and Stock at 31st Dec.2006 as 6,000.00.

Kamau’s Trading A/c

For the Year ended 31st Dec. 2006.

Opening Stock 5000 Sales 35000

Add Purchases 25000

Cost of good available for sale 30000

Less Closing Stock 6000

Cost of goods sold 24000

Gross Profit c/d 11000 . .

35000 35000

Gross profit b/d 11,000

2. PROFIT AND LOSS ACCOUNT

It is a financial statement which shows the net profit or loss of a business for a given period. It is
used to ascertain the net profits of the business. Net Profit (NP) is the difference between gross
profit and selling expenses, distribution expenses and administration expenses of the business. It
may be defined as excess of gross profit over the expenses of the business incurred to conduct
the business transaction.

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 Give examples of business operating expenses and incomes?

Some examples of business operating incomes include rent received, commission earned,
reduction in the provision of bad and doubtful debts and dividend received while operating
expenses include salaries and wages paid, rent paid, discount allowed, depreciation and increase
in the provision of bad & doubtful debts.

The Net profit or loss obtained in the profit and loss account is transferred to the capital account
of balance sheet. The net profit is added to the capital account while the net loss is subtracted
from the capital account.

In general, the preparation of income statements helps to ascertain the profits or losses incurred
by the business. This always requires the preparation of a trading, profit and loss account which
takes the following steps.

1. To the opening stock, add net purchases (purchases less returns outwards (purchase
returns) and carriage inwards and then subtract the value of closing stock to obtain the
cost of goods sold

2. To sales, subtract sales returns (returns inwards) to ascertain net sales.

3. The difference between cost of sales and the net sales gives gross profit (when the cost of
sales is less the net sales) or gross loss (when net sales is less cost of sales).

4. To gross profit, add all other revenues (incomes) to the business to obtain total receipts

5. To gross loss, add all costs incurred for the smooth running of the business (expenses) to
obtain total expenses

6. The difference between total receipts and total expenses gives net profit (when total
revenues exceed total expenses) or net loss (when total expenses exceed total receipts).

The following trial balance was extracted from the books of Biashara Enterprises as
st
at 31 December 2009.

Item Dr (Ksh.) Cr (Ksh.)

Opening stock 3000

Purchases 4050

Sales 6620

Carriage inwards 90

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Returns outwards 80

Returns inwards 120

Salaries and wages 520

Electricity 190

Rent 240

General expenses 70

Carriage outwards 110

Discount allowed 150

Insurance 500

Stationery 360 . .

6700 6700

Additional information: closing stock was valued at Ksh. 550

Required: prepare Biashara Enteprises trading, profit and loss account for the year ending 31 st
December 2009.

DEPRECIATION: As seen earlier, all assets except land depreciate or

loose their deported value over a period of time. This means that a fixed asset except land is
expected to loose some of its usefulness as it gets older. Three factors are considered in
determining the amount of depreciation expense to be recognized each period. These are the
fixed asset’s initial cost, its expected useful life and the residual value, scrap value, salvage
value, or trade-in value. A fixed asset’s residual value or expected useful life at the end of its
useful life must be estimated at the time the asset is placed in service. There are three methods
used in computing depreciation for its depreciable assets namely the straight-line, units of
production, and declining-balance.

The straight line method provides for the same amount of depreciation expense for each year of
the asset’s useful life. It is computed by D = (C- S)/N where: D: - Annual charge for
depreciation, C: - Original cost of asset, S: - Scrap value (Residual value) and N: - Number of
years (expected life of the asset).

For example, assume that the cost of a depreciable asset is £24,000, its estimated residual value
is £2,000 and its estimated life is 5 years, then,

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The annual depreciation = (Cost – Estimated residual value)/estimated life

=(£24,000 – £2000)/5 = £4400.

Now, the annual depreciation may be converted to a percentage of the depreciable cost. The
percentage is determined by dividing 100% by the number of years of useful life. The annual
depreciation of £4400 can be computed by multiplying the depreciable cost of £22,000 (£24,000
– £2000) by 20% (100%/5).

The straight line method is simple and is widely used as it provides a reasonable transfer of costs
to periodic expense when the assets use and the related revenues from its use are about the same
from period to period.

Units of Production Method is when the amount of use of a fixed asset varies from year to
year, the unit of production method is appropriate. The units of production method provides for
the same amount of depreciation expense for each unit produced or each unit of capacity used by
the asset. To apply this method, the useful life of the asset is expressed in terms of units of
productive capacity such as hours or miles. The total depreciation expense for each accounting
period is then determined by multiplying the unit depreciation by the number of units produced
or used during the period. For example, assume that a machine with a cost of £24,000 and an
estimated residual value of £2,000 is expected to an estimated life of 10,000 operating hours. The
depreciation for a unit of one hour is computed as follows:

Cost – Estimated Hours = Hourly depreciation i.e. £24,000 – £2000/10000 =£ 2.20

Declining-Balance Method provides for a declining periodic expense over the estimated useful
life of the asset. It is also called the reducing balance method. This is calculated as D = R(C-A)
where: R = 1- n√S/C, R:-Rate of depreciation, A:-Accumulated depreciation.

Example

A business has just bought a machine for £8,000. It will be kept in use for 4 years, when it will
be disposed off for an estimated amount of £500. Prepare a comparison of the amounts charged
as depreciation using both methods.

Solution:

Using Straight Line Method, depreciation is computed as:

Cost of Asset – Residual Value/No. of useful years = £ (8000 – 500)/4 = 7500/4 = £1875.
Thus,

For Year 1: 8000 – 1875 = 6125

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 For Year 2: 6125 – 1875 = 4250
For Year 3: 4250 – 1875 = 2375
For Year 4: 2375 – 1875 = 500.

Using the Reducing Balance Method and Take 50% of the Asset Value then

For Year 1: 50% X 8000 = £4000. Hence new value is 8000- 4000 = £4000
For Year 2: 50% X 4000 = £2000. Hence new value is 4000 – 2000 = £2000.
For Year 3: 50% X 2000 = £1000. Hence new value is 2000– 1000 = £1000
For Year 4: 50% X 1000 = £500. Hence new value is 1000 – 500 = £500

This illustrates that using the reducing balance method has a higher charge for depreciation in the
early years and lower charges in the later years.

Final Accounts Adjustments: Their purpose is to show the true profits

(Gross & Net) of the business and to show the correct view of the state of the business financial
affairs at a particular date. They include depreciation of fixed assets (minus in fixed assets), the
provision for bad and doubtful debts (minus from debts), accruals (Add current liabilities) and
pre-payments (add current assets). The following adjustments are performed in order establish
the true value of expenses and other items.

Accruals (Outstanding Expenses): If annual accounts of a business are prepared on 31st

December some expenses like rent, wages, and salaries may not be paid in December but in the
following year. Such expenses are called outstanding expenses or accrued expenses. Outstanding
expenses are debited in the trading, profit and loss account along with concerned expenditure and
also recorded in the liability side of the balance sheet.

Pre-Payments/Prepaid expenses: If expenses of next year are paid during the trading period
then such are known as pre-payments. Such advanced payments are deducted from concerned
expenditure in the debit side of the profit and loss account and they also appear on the asset side
of the balance sheet.

Provision for bad debts: Experience shows that some part of outstanding debts of the last date
of the accounting period become irrecoverable. The anticipated loss must be taken into account
for the calculation of the correct amount of Net Profit. For this purpose a provision for bad &
doubtful debts is calculated and is charged into the profit & loss account. This provision is credit
to the provision for bad &doubtful debts and it is shown as a deduction from the total debtors in
the balance sheet.

Example

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The following balances were extracted from the books of XY Company as at 31 st December,
2006.

Stock as at 1st Jan 2006 50,000 Land and buildings 240,000

Debtors 90,000 Purchases 280,000

Salaries & Wages 35,000 Fixtures & Fittings 25,000

Sales 520,000 Discount allowed 7,500

Discount received 4,500 Land & Machinery 140,000

Rates 5,600 Advertising 10,400

Insurance 3,800 General expenses 7,200

Provision for bad debts 1,800 Creditors 58,000

Cash in hand 2,400 Bank overdraft 18,600

Drawings 6,000 Capital 300,000

Additional Information

1. Depreciation is provided on straight line method on land and machinery at 10% per
annum and fixtures and fittings at 15%.
2. Provision for bad debts is to be increased to an amount equal to 40% of sundry debtors.
3. Prepaid insurance 500
4. Rates accrued 400
5. Closing stock was valued at 60,000
6. During the year the owner of the business took goods worth Kshs. 2000 for personal use.

Required: Prepare a Trading Profit and Loss account of the business for the year ended 31 st
December, 2006.

Solution :

XYZ company Trading Profit and Loss Account for the Year ended 31st December 2006

Dr (Kshs.) Cr (Kshs.)

Sales 520,000

Opening stock 50,000

Add Purchases 280,000

Goods Available for sale 330,000

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Less closing stock 60,000

Cost of goods sold 270,000

Gross Profit 250,000

Add discount received 4,500

254,500

Expenses

Salaries & Wages 35,000

Discount allowed 7,500

Rates 5600

Add Rates accrued 400 6,000

Advertising 10,400

Insurance 3,800

Less Insur. Pre-paid 500 3,300

General Expenses 7,200

Provision for bad debts 34,200 (1)

Dep. on Plant & mach. 14,000 (2)

Dep. on fixtures & fit. 3,750 (3)

Total expenses 121,350

Net Profit 133,150

254,500 254,500

EXPLANATORY NOTES

(1) Provision for bad debts = 40% X 90,000 = 36,000. Hence, 36,000- 1,800 = 34,200

(2) Depreciation on plant & machinery = 10% X 140,000 = 14,000

(3) Depreciation on fixtures & fittings = 15% X 25,000 = 3,750

3. BALANCE SHEET

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A balance sheet is a financial statement showing the financial position of a business at a specific
date. It shows what the business is owing to others and owning. It thus shows the assets,
liabilities and capital of a business as at a given date. Hence is used in the business to prove the
validity of the accounting equation.

Now, let us discuss further the concept of capital. Firstly and as seen earlier, capital is a special
liability. As a liability, it is subject to change at the end of the trading cycle due to the following

1. Drawings: this includes cash or items taken from the business by the owner for private
use. This therefore reduces the capital of the business

2. Profits: this refers to excess sales over the cost of sales and other expenses. This is
therefore the net profit attributed to the owners and hence results in an increase in capital
of the business

3. Losses: this is a situation where the cost of sales exceeds the value of sales and other
trading incomes. This is thus the net loss that the owner will suffer as this will reduce the
capital of the business.

4. New investments: this refers to additional assets or cash brought into the business by the
owner. This therefore increases the value of capital in the business.

Secondly, we discussed that capital may be categories as equity capital or loan capital. However,
capital is further classified as follows:

1. Capital owned: this is the total amount invested in the business by its owners. It is also
called owners or equity capital. Thus capital owned can be expressed as cCapital at start
plus (profits and new investments) less (drawings and losses)

2. Borrowed capital: this is the sum total of money borrowed from financial institutions
such as commercial banks and development finance companies. This is also called loan
capital

3. Working capital: this refers to the excess current assets over current liabilities i.e current
assets less current liabilities. This form of capital is important as it is used to measure the
solvency of the business i.e the ability of the business to settle its debts from its internal
sources. It is also used to show if the assets of the business are underutilized in the
running of the business.

4. Fixed capital: this is the sum total of all the fixed assets in the business.

5. Working capital: this refers to the sum total of all the business finances available for its
operations. It is thus the sum of capital owned and borrowed capital or fixed capital and
working capital.

Ensuing from the above discussion, let us now present the balance sheet in the following
examples.

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 Example 1

Consider the above example on XYZ Company, the balance sheet will thus be as follows.

XY Company Balance Sheet for the Year ended 31st Dec. 2006

Fixed Assets

Shop premises 50,000

Fixtures & Fittings 13,000

Fixed capital
63,000

Current Assets

Stock 8,900

Debtors 11,000

Prepayments (rent) 200

Bank 10,400

Cash 4,800

35,300

Less Current Liabilities

Creditors 12,800

Accruals (electricity) 300 13,100

Working Capital 22,200

Capital employed 85,200

FINANCED BY

Capital 43,000

Add Net Profit 29,400

72,400

Less withdrawals 10,200

capital owned 62,200

Add long term liabilities (e.g. loan) 23,000

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 85,200

Example 2

Mr. Wasike has given you the following balances extracted from his books as at 30 th September
2008.

Item Amount Item Amount

Cash at hand 1,200 Cash at bank 11,000

Stock at (1/9/2008) 21,000 Debtors 8,000

Creditors 10,000 Returns inwards 500

Sales 56,000 Purchases 20,500

Capital 14,900 Salaries 4,000

Water & Electricity 600 Postage 200

Drawings 900 Stock (30/9/2008) 13,500

Furniture & Fittings 7500 Motor Van 35,000

Loan from ICDC 30,000 Rent received 1,200

Office rent 1,700

Required:

a) Prepare a Trial Balance for the period ending 30/9/2008.

b) Prepare his Trading, Profit & Loss Account for the month.
c) Prepare his balance sheet as at 30/9/2008.

Solution

(a) Mr. Wasike’s Trial Balance for the period ending 30th September 2008

Details Dr. Cr.

Cash at hand 1,200

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Cash at bank 11,000

Stock at (1/9/2008) 21,000

Debtors 8,000

Creditors 10,000

Returns inwards 500

Sales 56,000

Purchases 20,500

Capital 14,900

Salaries 4,000

Water & Electricity 600

Postage 200

Drawings 900

Furniture & Fittings 7500

Motor Van 35,000

Loan from ICDC 30,000

Rent received 1,200

Office rent 1,700 . .

112,100 112,100

(b) Mr. Wasike’s Trading Profit & Loss Account for the year ended 30/9/2008

Sales 56,000

Less Returns inwards 500

Net Sales 55,500

Less: Cost of Sales

Opening stock 21,000

Add purchases 20,500

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 Cost of goods available for sale 41,500

Less closing stock 13,500 28,000

Gross Profit 27,500

Add Rent received 1,200

Total income 28,700

Less Expenses

Salaries 4,000

Water 600

Postage 200

Office rent 1,700 6,500

Net Profit 22,500

(c) Mr. Wasike’s Balance Sheet as at 30/9/2008

Fixed Assets Shs.

Motor van 35,000 Capital 14,900

Furniture & Fittings 7,500 42,500 Add Net Profit 22,200

37,100

Current Assets Less Drawings 900 36,200

Cash at hand 1,200 Add loan (ICDC) 30,000

Cash at bank 11,000 Creditors 10,000 40,000

Closing stock 13,500

Debtors 8,000 33,700

76,200 76,200

Example 3

The following Trial Balance was extracted from the books of James as at 31st December 2009.

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James Trial Balance as at 31st December 2009

DR (Ksh.) CR(Ksh,)

Sales 67,000

Purchases 42,600

Lighting & heating expenses 1,900

Rent 2,400

Wages: Shop Assistant 5,200

General expenses 700

Carriage outwards 1,100

Buildings 20,000

Fixtures & Fittings 7,500

Debtors 12,000

Creditors 9,000

Bank 1,200

Cash 400

Drawings 9,000

Capital 31,000

Stock (at December 2008) 3,000 . .

107,000 107,000

Required: Using the information from the Trial Balance,

a) Prepare James’s Trading Profit & Loss Account.

b) Prepare a Balance Sheet as at the last day of the business.

Solution:

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(a) James Trading and Profit and Loss Account for the Year ending 31st December 2009

Dr(Kshs.) Cr(Kshs)

Sales 67,000

Less cost of goods sold:

Opening stock 3,000

Add Purchases 42,600

45,600

Less Closing stock (5,500) 40,100

Gross Profit 26,900

Less Expense:

Wages 5,200

Lighting & heating expenses 1,900

Rent 2,400

General expenses 700

Carriage outwards 1,100 11,300

Net Profit 15,600

(b) James Balance Sheet as at 31st December 2009

Kshs. Kshs.

Fixed Assets

Buildings 20,000

Fixtures & Fittings 7,500 27,500

Current Assets

Stock 5,500

Debtors 12,000

Bank 1,200

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Cash 400

19,100

Less Current Liabilities

(Creditors) (9000) 10,100

37,600

Financed by:

Capital: Balance as at 1st Jan 2009 31,000

Add Net Profit for the year 15,600

46,600

Less Drawings (9000)

37,600

2.2.2 INVESTMENT ANALYSIS

Investment: this refers to commitment of funds into a business for purpose

of returns in future. Thus an individual who enters into a business expects to get returns in terms
of profits. It is however important to note that sometimes businesses incur gross loss and end up
getting a net profit as a result of the other trading activities of the business. Thus gross loss
doesn’t imply there will be a net loss at the end of the financial period. It is necessary at this
point to look at circumstances under which gross loss may occur in a business. This include
when there is

1. Slow movement of stock.

2. Drawing in stock-the owner of goods withdraws some goods for personal use.
3. Poor customer relationship resulting to poor sales.
4. Inadequate advertising.
5. Some goods may be stolen or vandalized.
6. Tight competition in the market.
7. Some goods may become obsolete.

What other reasons may cause gross loss in a business?

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Ensuing from this, there is need therefore to think critically on what to invest in. Below are some
considerations you can make in order to make a viable investment.

1. Return investment – include returns such as interest, profit etc. Usually the higher the
returns, the better the investment.
2. Security of investment- one should invest where there are fewer or minimal risks.
3. Degree of liquidity- this refers to how easy the investment can be converted into cash.
For a viable investment there is need to invest where it is conveniently easy to convert an
investment into cash.
4. Pay back period- this is how long it takes for an investment to pay back the initial
capital invested. Usually, invest where it takes a short period to get back the initial capital
invested.
5. Tax policy-invest in areas whose profits are tax-free or have a lower tax rate.
6. Growth rate – invest in activities whose funds value appreciate with time rather than
those that depreciate.

Mr. XYZ has been retrenched from his job and given Kshs. 3,000,000 as a lump
sum and intends to venture into business. He is undecided as to whether to invest
in matatu business or build rental houses in an upcoming town and approaches
you with your classmate to advise him on which option he should invest in.
Discuss and advise what Mr. XYZ should invest in.

2.2.3 FINANCIAL RATIOS

These are measures that indicate the performance of an investment. They provide quantities
which show how the level of success of a business. Before we discuss some basic ratios, let us
first highlight the advantages and disadvantages of ratios in analyzing the performance of a
business.

MERITS OF FINANCIAL RATIOS

1. Analysis of financial position of business-ratios help to make investment decisions

especially those relating to lending and borrowing.
2. Simplify accounting figures- ratios summarize and systemize financial figures for easy
understanding. They often give relationship that exists between different segments of a
business.
3. Assesses the operational efficiency of a business- they assists in revealing liquidity
profitability, solvency or insolvency of a business.
4. Forecasting business trends for successive financial years i.e shows upward or downward
trend of business operations.

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 5. Locate weak points of a business useful in both short term and long term planning of
business activities.
6. Provide comparison of the performance of various departments within a firm.

DEMERITS OF FINANCIAL RATIOS

1. Give false results if incorrect accounting data is used eg if stock is overstated/understated,

the ratio will give a false impression of the business.
2. Are based on historical data and given that business world is dynamic, changes in the
market structure may not be revealed.
3. Changes in the price level of commodities render comparison for various years difficult.
4. Can’t act as a single denomination for comparison of two different firms operating under
two different environments e.g monopolistic and competitive environment.

Now, to determine the viability of the investment, the following are the
basic ratios that are necessary for evaluating the performance of the business

1. Average stock- this is the average value of stock held by a business. It is computed by
Average Stock = (opening stock+closing stock)/2

Interpretation: A high value shows low movement of stock and hence the proportion of money
invested is tied in stock.

2. Rate of Stock Turnover (ROST) - this reveals the number of times a business was re-stacked
during the trading period. It is calculated as

cos tofsales
R.O.S.T =
averagestock

Interpretation: A higher rate (usually more than 4) shows faster movement of stock

3. Creditors ratio – this establishes the average credit period given by creditor’s to settle their
accounts. It is computed as

creditors
Creditors ratio = x365days
crditpurch ases

Interpretation: usually 30 days are taken to be a low credit ratio while 60 days are taken to be a
high ratio.

4. Debtor’s ratio- this is used to establish the average credit period allowed to debtors to settle
their accounts. It is determined as

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 debtors
Debtor ratio = x365days
crditsales

Interpreted similarly to creditors ratio above

5. Acid test ratio/quick ratio/liquidity ratio- this measures the precision with which a business
can be able to meet its debts without selling all the stock. It is determined by

currentassets  stock
Quick ratio =
currentlia bilities

Interpretation: A ratio of 1:1 is taken to be normal while a high ratio (eg 3:1) means high rate of
cash is not utilized.

6. Current ratio – this measures the capability of the business to pay its debtors. It’s computed
currentassets
as Current ratio =
currentlia bilities

Accepted ratio is 2:1 while a higher ratio (e.g. 3:1) means the business is able to pay its bills in
time,

7. Rate of return on capital (RORC) = this measures the returns on capital invested and is
computed as
netprofit
RORC= x100
capital

The following information was extracted from Pesa’s books of accounts

Stock 1/1/05 40,000 bank overdraft 40,000

Stock 31/12/05 60,000 Creditors 50,000

Net Sales 354,000 Capital 250,000

Net Purchases 320,000 Indirect expenses 4,000

Stock 90,000 Debtors 70,000

Cash 20,000

Required: calculate the following ratios- average stock, ROST, Return on capital, current ratio,
liquidity ratio, Debtor ratio, creditors’ ratio and comment on the performance of the business.

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 ASSIGNMENT

Kimtai started Business on 1/1/2008 by putting £60,000 into a bank account for the business.

2/1/2008, he paid sh.480 by cheque for rent for the two months January and February

2/1/2008, bought warehouse fixtures paying by cheque immediately for sh.7200.

3/1/2008, withdrew sh.900 cash from the bank for business use.

4/1/2008, paid wages in cash for three weeks of January sh.720.

5/1/2008, bought goods of sh.4200 paying for them immediately by cheque.

6/1/2008, bought goods on credit from T. Price sh.1800, F. Radcliffe limited sh.7200, C. Norton
& Co. sh.3,300.

8/1/2008, bought motor van by cheque for sh.14,400.

11/1/2008, paid for motor expenses sh.90 by cash.

12/1/2008, sold goods on credit to K. Kitchen limited for sh.1920 and E. Griffith for sh.4200.

13/1/2008, cash sales sh.840

15/1/2008, paid for light and heat by cheque for the 1st two weeks of January sh.480

16/1/2008, paid insurance by cheque sh.720 for the 12 months to 31st Dec 1995

19/1/2008, bought goods on credit from P. Goddard for sh.9600

21/1/2008, sold goods on credit to k. Kitchen limited for sh.20,400 and N. Fryer sh.720

24/1/2008, Kimtai withdrew sh.1,500 by cheque for his own personal use.

26/1/2008, received cheque from E. Griffith sh.4095, after deducting sh.105 cash discount. Also
received a cheque from K. Kitchen on account by sh.3000

27/1/2008, returned goods to C. Norton & Co. sh.720, and also returned goods to F. Radcliffe
sh.600

29/1/2008, paid by cheque after deducting 5% cash discount to the amounts of T. Price and P.
Goddard

30/1/2008, Goods returned to us (Kimtai Business) by K. Kitchen limited sh.204 and N. Fryer
sh.120

31/1/2008, Kimtai withdrew sh.120 cash for his personal use.

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1. Enter the above transactions in the books of Kimtai, balance off the accounts, and extract a
trial balance.

2. Prepare Trading Profit and Loss Account and a Balance Sheet for the month ended 31 st
January 2008.

3. Comment on the solvency of Kimtai business.

2.3SUMMARY

In this topic we have learnt that investment is commitment of funds for returns in future. The
returns are usually in form of profits enjoyed at the end of the investment. These profits are
determined by preparing final accounts namely the trading account to establish the gross profit
and the profit and loss account to determine the net profit of the business.

We have also discussed how to evaluate the financial position of a business by preparing a
balance sheet. This in essence confirms the validity of the fundamental accounting equation
discussed in topic one.

Finally, we have discussed how to determine the viability and performance of an investment by
computing financial ratios that help explain the solvency of the business.

2.4 SELF CHECK

SELF CHECK 2
1. The following balances were extracted from the accounting records of John as on December
31st 2011.(the currency is the Kenya shilling).

Item Amount Item Amount

Capital 250,000 Stock (1/12/2011) 25,000

Plant & Machinery (cost) 250,000 Motor Vehicle (cost) 80,000

Provision for depreciation of Purchases 360,000

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a)Plant & machinery 20,000 Sales 600,000

b)Motor vehicles 6,000 Sales returns 40,000

Purchases returns 20,000 Wages & salaries 60,000

Rent & Rates 15,000 Water & Electricity 8,600

Postage & Telephone 7,500 Bad debts Written off 1,500

Provision for bad debts 1,000 Discount allowed 5,000

Discount received 4,000 Carriage inwards 2,500

Carriage outwards 3,000 Debtors 5,500

Creditors 46,600 Cash at hand 6,600

Cash at bank 30,000

Additional Information

1. Stock on 31st December 2011 was valued at 22,500

2. Depreciation is to be charged at 10% of cost of plant & machinery and 20% of cost of
motor vehicle.
3. Accrued rent (not paid) 3,000
4. Pre-paid rates 1,000
5. Outstanding electricity expense 600

Required: using the balances provided

a) Extracted John’s Trial Balance as at 31st December 2011 (2marks)

b) Prepare John’s
(i) Trading Profit & Loss Account for the year ending 31st December 2011 (8marks)
(ii) Balance Sheet as at the last day of the business. (5marks)

2 The following information was obtained from the books of accounts of Mwali Enterprises as
at 30th June 2010.

Capital Kshs. 315,000 Debtors Ksh. 40,000

Stock Kshs. 20,000 Outstanding salaries Kshs.4,500

Drawing Kshs.35,000 Cash Kshs.10,000

Insurance Kshs.11,000 Creditors Kshs.15,000

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 Rent Kshs.8,000 Prepaid Insurance Kshs.3,500

Premises Kshs.200,00 Land Kshs.56,000

Carriage out Kshs.6,000 Discount received Kshs.5,000

Bank Kshs.20,000 Discount allowed Kshs.4,000

Gross Profit Kshs.75,000

(a) Prepare Mwali enterprises

(i) Profit and loss account (4 marks)

(ii) Balance sheet as at 31st June 2010 (6 marks)

(b) Calculate Mwali Enterprises

(i) Liquidity ratio (2 marks)

(ii) Current ratio (2 marks)

(iii) Comment on the solvency of Mwali Enterprises (1 mark)

2.5 Score Board

Range of marks Level of Performance

25-30 Very good

15-24 Good

11-14 Satisfactory

0-10 Read the topic again

2.6 LEARNING OUTCOMES

You have now completed the topic on public finance, please tick in the column which reflect
your understanding of the various learning outcome listed below.

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No. Learning Outcome Sure Not Sure

1. I can now prepare a trading account of a business

2. I can now explain and compute the concepts of

depreciation, bad debts, accruals and prepayment

3. I can now prepare a profit and loss account

4. I can now prepare a balance sheet for a business

5. I Can now make a choice on what to invest in

6. I can now determine the viability and performance

of an investment

If you have put a tick at the “not sure” column, please go back and study that section in the topic
before proceeding.

If you have ticked “sure” in all the rows in all the columns you are ready for the next topic

Congratulations! You can continue to the next Topic

KAFUCO ESM104 GOOD MOMS

2.7 FURTHER READING

Deakin B.E. and Maher W.M(1987): Cost Accounting, 2nd Ed. U.S.A.

Ferries R. Kenneth (1993): Financial Accounting and Corporate Reporting, 3rd Ed. Irwin

Mullings G.F and Shao P.S (1979) Mathematics for Management and Finance gage publishers,
Canada

Slater R. and Curwin, J(2002):Quantitative Methods for Business Decisions, 5th Ed. Thomson

KAFUCO ESM104 GOOD MOMS

 TOPIC THREE

INTEREST, DISCOUNT AND COMMISSION

3.0 INTRODUCTION

In topic one, we discussed book keeping and investment analysis. In this topic, we are going
focus on the interests, discounts and commissions. We shall discuss the computation of the
various types of interests, discounts and computation. Further, we shall introduce the concept of
inflation.
3.1 OBJECTIVES

By the end of this topic, you should be able to:

 Explain the concept of interest, discounts and commission
 Compute interest, discount and commission
 Describe the concept of annuity and sinking fund

3.2 SECTIONS OF THE TOPIC

In this topic, we shall cover the following sections:
Section 1: Interest
Section 2: Discount
Section 3: Commission

These sections are discussed below.

3.2.1 INTEREST

Interest is the payment made for the use of money. It may be paid at
simple or compound rates and hence classified as simple interest and compound interest. Let us
compute each of the following.

1. SIMPLE INTEREST
If money is invested at simple interest, it means that payment is made each year on the original
investment. This is computed as follows:
A = P + Prt where
A- Value of the investment at the end of the period.
P- The amount invested
r- Rate of interest

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 t- Number of years.

Example

Calculate the value of an investment of Kshs 5000 after 3 years, if simple interest is paid at an
annual rate of 5%.

A= 5000 + (5000× ×3 ) = 5750

Thus the investment will generate sh. 750 (sh. 5750 – sh.5000) after 3 years.

2. COMPOUND INTEREST
If money is paid at compound interest, interest payment each year is not on the original sum but
on the current value of the original investment i.e. the original investment plus the accumulated
interest. Therefore the amount at the end of every year is obtained as
A= P+ Pr. Thus for
1st year P (I+r)
2 nd year P (I+r)2
3rd year P (I+r)3
Hence for t years then tth year P (I+r)t
In general the compound interest is computed using the discounting formula as A=P (I+r) t thus

P=

Example 1

Calculate the value of an investment at the end of six years if one thousand shillings is invested
at 4% per amount compound interest.

Solution

From A=P (I+r) t then A=1000 (1+ 0.04)6

Taking logarithms we have = 3+ 6(0.017) = 3.1020

Taking antilogarithms we have A=Shs. 1265

Hence compound interest earned is shs. 1265- sh. 1000 = sh.265.

Example 2

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Mary borrowed sh.25000 repayable after every 4 months at an interest of 16% p.a compounded
every 4 months. How much interest did she pay on the amount borrowed?

Solution

From A=P (I+r) t then, t= 4/12x3=1, r=16-:12/4 16/3 and P= 25000.

Therefore A=25000 (1+16/300) =25000(1+0.5333)=26333.33

Thus interest paid=26333.33-25000=sh.1333.33

If the interest rates charge during a period of deposit or investment, then

the compounding formula should be amended as follows:

A=P (I+r1)X (I+r2)n-x

A-value of the investment at the end of the period

P-the amount invested

r1- initial rate of interest

x- Number of years in which interest rate r1 applies.

r2 –the next rate of interest

n-x – the number of years in which the interest rate r2 applies.

Example 3

If sh. 80000 is deposited to earn 10% interest p.a for 3 years and then 12% p.a in the subsequent
years, what would be the total amount of deposit on the basis of compound interest at the end of
five years?

Solution

A=80000(1+ )3 (1+ )5-3 =80000(1.1)3 (1.12)2

A=80000(1.331)(1.2544) =133568.50

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 Inflation: this is the increase in the price of a commodity over time. Thus
in order to find out the future inflated prices, the formula for compound interest is applied.

Example 4

The present price of an article is sh. 5000. If the inflation rate is 12% annually, find the price of
this article after 3 years?

Solution

From A=P (I+r) t then, A= 5000(1+ ) 3 = 7024.60

Thus the price of the article shall have increased to sh.7024.60 after 3 years.

EXERCESE

1. If sh. 2000 is invested at 6%p.a, how much will it be worth in 8 years time?
a) At simple interest
b) At compound interest
2. Find the amount at the end of 10 years when sh. 400 is invested at 4% p.a compound
interest?
3. Find the sum a man has to invest on his 20th Birthday so that he may be able to draw out a
lump sum of sh. 2000 on his 40th Birthday, the investment being made at 5% p.a
compound interest.
4. A 5000 Government bond is due to mature in 12 years time. What is it worth today, if the
current rate of interest is 5%p.a and compound interest is assumed?
5. Peter purchases goods from Mbao manufacturers on the following terms: if the gross
price is over sh. 120000, he gets a trade discount of 20% and a cash discount of 5% if he
pays within one month, 3% if paid in 2 months and no cash discount after 2 months.
Calculate the amount which Peter will pay if he if he bought goods worth sh. 150000 and
paid
a) In one month
b) In two months
c) In four months

Assume that you are to retire in 25 years time and you intend to save sh.2000000 by that
time. If you decide to deposit sh.7000 yearly in a finance company at 20% compound

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 interest p.a beginning on your 40th birthday, show using appropriate computations if you
will achieve the objective given that retirement age is 65years.

3.2.2 DISCOUNTS

This is a reduction in the initial price of a commodity. It is the

allowance given to a trader or a customer on the goods purchased. There are two kinds of
discounts:

1. TRADE DISCOUNT
This is given in view of quantity purchased. The price is reduces at a specific percentage. It is
usually given between traders.

2. CASH DISCOUNT
This is given to induce the customers to pay their accounts promptly. It is usually graduated
depending on the time of payment after the transaction. For instance it can be 5% if payment is
made within 30 days or 2% if payment is made within 60 days e.t.c. Further, cash discount is
calculated on the amount remaining after deduction of any trade discount.

EXAMPLE 1
Onyango sales his product at sh. 20 per unit. He gives trade discount of 20% to customers who
purchases between 50-100 units and 30% on more than 100 units purchased. If a customer
bought 80 units from Onyango, calculate:
i) Trade discount per unit
ii) The net amount paid by the customer

Solution
(i)Total amount due =80 units × sh. 20 per unit =sh. 1600

Now,trade discount per unit = 20=sh. 4

Hence cost price per unit= sh.16

(ii)Total amount paid = sh. 16 80units =sh. 1280

Suggest an alternative working to this question

Example 2

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 Kariuki sold goods to Otieno on credit for sh. 25000 as at 1st January 2010. The terms of
payment were 5% per month cash discount. If the payment was made on 28th January 2010,
calculate:

i) Cash discount

ii) Net amount paid by Otieno.

Solution

(i) Cash discount = 25000= sh.1250

(ii) Amount paid by Otieno= sh.25000 - sh.1250= sh.23750

Series: A set of numbers which can be obtained from some definite law is
called a series or a progression. Each of the number forming the set is called a term of the series.
For instance, consider the following cases

a) 1, 4, 7, 10……………………… (+3 )series

b) 1,2,4,8,16 ………………………..( ) series
c) 1,4,9,16…………………………….12 ,22 ,32,42
Give more examples of sequences.

Arithmetic progression (AP): This is a series in which each

term is obtained from the preceding one by addition or subtraction of a constant
quantity. This quantity is known as the common difference denoted as d. now,
consider the following cases:
1. 600,650,700,750…………………(d= 50)
2. 8,12,16,20…………………………..(d= 4)
3. 14,9,4,-1………………………………..(d= -5)
4. 1,4,7,10………………………………….(d= 3)
From these cases, you will notice that if the first term is a then the subsequent terms cam be
generated by adding d i.e a, a+d, a+2d, a+3d………………………
This therefore gives the general form of the AP as a + (n-1)d
Similarly, we can find the sum of the given number of terms (n terms) of an AP series. Generally
this is computed as

KAFUCO ESM104 GOOD MOMS

 Sn = =n

Example
Find the sum of the first 20 terms of the series 7, 14, 21, 28………
Solution
From the series, the first term a=7 and the common difference d=7 with n=20

Therefore S20= = 10 =20(7+66.5) =1470

Geometric progression (GP): this is a series in which each term is

obtained from the proceeding one by multiplying or dividing by a constant quantity. This
constant quantity is known as the common ratio and is denoted as r.

Now consider the following series

3, 6, 12, 24, _ _ _ (r=2)

16, 4, 1, , _ _ _ (r= )

1, -3, 9, -27, _ _ _(r= -3)

Taking the first term as a then the subsequent terms can be generated by multiplying by r hence
the following trend is evident a, ar, ar2, ar3, _ _ _

This therefore gives the general form of the GP as ar(n-1)

Similarly, we can find the sum of the given number of terms (n terms) of a GP series. Generally
this is computed as

Sn=a (1-rn ) /1-r for r 1 Or Sn=a (rn -1)/r-1 for r 1

Example

Find the sum of first 6 terms of the series 1,-4, 16,-64……….

Solution

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From the series this is clearly a GP series with a=1and r= -4

Now, since r<1 then Sn=a (1-rn ) /1-r

Therefore S6= 1(1+46 )/1+4 =4096/5=819.2

How else would you get the sum of the first 6 terms of this series?

Annuity: this is a series of cash flows for the same amount over
consecutive periods. The periodic cash flow or flows should be payment or receipts of equal
amounts. Examples of such flows include contribution to life insurance policies and the pension
schemes. Now, the constant payment or receipts can be effected at the beginning or at the end of
the expected period. When the cash flows occur at the end of the expected period, then the
annuity is known as differed annuity while when the cash flows occur at the beginning of each
period, then the annuity is called annuity due.
To compute the value of an annuity, the following formula is used.

FVA=A /r where

FVA: is the future value of an annuity

A: is the constant payment or receipts

r :is the compound interest rate or discount rate.

N: is period of the savings (investment)

Example

Suppose John deposits sh. 2000 in a savings account annually for 5 years and the deposit earn a
compound interest rate of 10%. What will be the value of these streams of cash deposits at the
end of 5 years?

Solution

Notice that A= 2000, r=10% , n=5

Thus, FVA= 2000 / 0.10 = SH.12210.20

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ALTERNATIVELY:

FVA=A (1+r)n-1 +A (1+r)n-2 + A (1+r)n-3 + A(1+r)+A

=2000(1.10)4 +2000(1.10)3 +2000(1.10)2 +2000(1.10) +2000

=2000(1.4641) +2000(1.331) +2000(1.21) +2000(1.10) +2000

=sh.12210.20

EXERCISE

1. Write down the first 3 terms and the eighth term of the series whose nth terms are:
a) 4n-5
b) 3n-1
c) -1n
2. Find the sum of 10 terms of an arithmetic progression of which the first term is 60 and
the last term is -104?
3. Insert 6 terms in an arithmetic progression between 2 and 30
4. Find three numbers in an arithmetic progression such that their sum is 27 and the product
is 504 (suppose we let the nos. be a-d , a and a+d )
5. Determine the first 5 terms of the geometric progression in which a1=2, a3 =18
6. Determine the first 5 terms of a geometric series in which a2,=36 ,a3 =108.

2.2.5 COMMISSION

This is an additional payment for motivation over some good work done. It
is usually paid to the agents, salesmen, stock brokers or managers on the basis of their
performance such as when they sell greater quantities than the usual. It is normally calculated
according to the terms agreed.

Example 1

Find the commission due to the salesmen in each of the following.

SALES Kshs.

1. Sh. 188,000 12.5%

2. Sh. 385, 000 7.5%
3. Sh. 848, 000 8%

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Solution

1. Commission= 12.5/100 188,000 =23,500

2. Commission=7.5/100 385,000 =28,875
3. Commission= 848, 000 = 67,840

Example 2

Chemiyot sells goods on commission basis for a firm in Eldoret. Commission is paid on sales as
follows in addition to his monthly salary of sh. 3000. On the first sh. 50000 of sales, he gets
nothing; on the next sh. 100000 of the sales he gets 4% and on the balance of sales thereof, he
gets 5%. Suppose Chemiyot sold goods worth sh. 350000 during December 2011. Calculate
Chemiyots total income for December 2011.

Solution

Total sales 350 000

Less commission free sales 50 000

300 000

Now for the first sh.100 000= 4%of100 000= 4000

For the Balance (300 000- 100 00) =200 000, 5%of200 000 =10 000

Thus total commission earned is 4000+10 000=14 000

Hence total income =salary +commission=14000 +3000 = 17 000

3.3 SUMMARY

In this topic we have learnt about interest, discount and commission. We have learnt that interest
is the payment made for the use of money and may be paid at simple or compound rates. If
money is invested at simple rate, it means that payment is made each year on the original
investment amount while if money is paid at compound rate, then interest payment for each year

KAFUCO ESM104 GOOD MOMS

is not on the original sum but on the current value of the original investment. Further, we defined
inflation the increase in the price of a commodity over time.

Moreover, we learnt that discount is a reduction in the initial price of a commodity and takes the
form of cash discount when payments are done immediately or trade discount when purchases
are done in large quantities. In addition, we have discussed that a series is a set of numbers which
can be obtained from some definite law and can follow an arithmetic or geometric progression.
Further, we learnt that a series of cash flows for the same amount over consecutive periods is
called an annuity and can either be differed or due.

Finally, we have discussed that commission is an additional payment for motivation over some
good work done and is usually paid to the agents, salesmen, stock brokers or managers on the
basis of their performance such as when they sell greater quantities than the usual.

3.4SELF CHECK

SELF CHECK 3

1. A firm rents its premises and the rental agreement provides for a regular annual increase
of sh. 2650. If the rent in the first year is sh. 8500,

i. What is the rent in the tenth year?

ii. How much rent in the total did the tenant pay for the premises over the ten years?

2. A government bond will be worth sh. 1000 in 10 years time. What is it worth today, if 5%
compound interest is assumed?

3. If the cost of an asset is sh. 15000 and the rate of depreciation is 10% per annum. Show the
amount of depreciation for 4 successive years.

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4. A firm buys a machine for sh.32,500 which is expected to last for 20years and have a scrap
value of sh.7500. If depreciation is on the straight line method, how much should be provided for
each year.

3.5 Score Board

Range of marks Level of Performance

25-30 Very good

15-24 Good

11-14 Satisfactory

0-10 Read the topic again

3.6 LEARNING OUTCOMES

You have now completed the topic on public finance, please tick in the column which reflect
your understanding of the various learning outcome listed below.

No. Learning Outcome Sure Not Sure

7. I can now define book keeping and its associated

concepts

8. I can open ledger accounts and record transactions

9. I can now extract a trial balance from the books of

accounts

10. I can now describe the errors that do not affect a trial
balance

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 11. I Can now prepare the final income statements of a
business

12. I can now determine the viability and performance

of an investment

If you have put a tick at the “not sure” column, please go back and study that section in the topic
before proceeding.

If you have ticked “sure” in all the rows in all the columns you are ready for the next topic

Congratulations! You can continue to the next Topic

1.7 FURTHER READING

Deakin B.E. and Maher W.M(1987): Cost Accounting, 2nd Ed. U.S.A.

Ferries R. Kenneth (1993): Financial Accounting and Corporate Reporting, 3rd Ed. Irwin

Mullings G.F and Shao P.S (1979) Mathematics for Management and Finance gage publishers,
Canada

Slater R. and Curwin, J(2002):Quantitative Methods for Business Decisions, 5th Ed. Thomson

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 TOPIC FOUR

PUBLIC FINANCE

4.0 INTRODUCTION

This topic focuses on the general management of public finances. It introduces you to the major
functions of the government in a country, sources of public revenue and principles that guide
public expenditures. Further, the concepts of the gross domestic product, gross national product
and the balance of payment are discussed. Finally, we shall discuss the process of budgeting.
4.1 OBJECTIVES

By the end of this topic, you should be able to:

 Explain the main functions of the government in a country
 Describe the various sources of public revenue
 Explain the principles guiding public expenditures
 Differentiate between the concept of gross domestic product, gross
national product and the balance of payments
 Explain the functions and process of budgeting

4.2 SECTIONS OF THE TOPIC

In this topic, we shall cover the following sections:
Section 1: Functions of the government
Section 2: Public revenue
Section 3: Public expenditure
Section 4: Budgeting

These sections are discussed below.

4.2.1 FUNCTIONS OF THE GOVERNMENT

What are the main functions of the government in your country?

There are various functions of the government just as there are for the father in the home. Below
are some of the functions of the government that you may have mentioned or you are aware of.

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 1. Protective function- the government is responsible to maintain peace and security in the
country and defend it against external aggression. It is therefore the duty of the
government to protect its citizens internally as during case of tribal clashes witnessed in
Mt. Elgon and other parts of the country and the post election violence of 2007 and 2008.
Further, the government protects its territories and any other invasions as the case of the
insurgence of the al-shabaab of Somalia and the merrile warriors of Ethiopia. This is done
by the Kenya Defence Forces.

2. Administration function-the government is responsible for the general administration of

the country through the devolved administrative units and the various ministries and
departments

3. Social function-the government provides social services to its citizens that are vital for the
welfare of the society. This includes provision of basic education and health services.

4. Development function- the government is responsible for the development of different

sectors of the economy. This sectors are deemed to contribute to the increases in the rate
of economic growth in a country and include development of irrigation, enhancement
transport and communications networks, industrial and agricultural system etc.

For the government to perform the above functions it is necessary that it

generates funds and spend it accordingly. Hence public finance involves financing state activities
to meet its functions. Specifically, public finance deals with public revenue and public
expenditure.

4.2.2 PUBLIC REVENUE

This deals with those amounts which are received by the government i.e
income of the government. The government receives revenue from various sources both
internally and externally. Internally the sources of government revenue include:

1. Tax-this is a compulsory contribution imposed on individuals to meet the expenses,

which are incurred for a common course. It is the main source of government revue as it
is done in various forms as it will be discussed under the topic on taxation in this module.

2. Fees- this is the amount received by the government against any direct service rendered
e.g road license fee, import license, moving animals from one place to another etc.

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 3. Prices- this are amounts received by the government from its engagement in commercial
services in the country eg railway, postage and telephone charges.

4. Special assessments –are amounts charged for a specific purposes eg if the

government charges a specific amount for establishment of a school, hospital or
college and construction of chiefs office or police post.

5. Fines-this include charges imposed on individuals for not obeying the laws of a country.
This includes charges on breaking traffic rules such as not belting while in a public
service vehicle or being found drinking illicit brews or outside the recommended hours.

6. State property- this includes income from government department such as forests, mines
and national parks.

7. Internal borrowing- the government may also get income through borrowing from its
citizens and financial institutions within the country.

4.2.3 PUBLIC EXPENDITURE

This involves spending of public revenue. This is done by observing the

following guiding principles of public expenditures

1. Principle of economy – this states that resources are scarce and thus no wastage should be
permitted. This means that public expenditures should in involve the use of resources up
to what is necessary. The fund should therefore be utilized prudently with minimum
wastage.

2. Principle of sanction-this states that public funds should not be used without proper
authorization (sanction). The expenditures should be authorized by the respective
authority such as the parliament. These funds must also be used for the purpose for which
they have been sanctioned.

3. Principle of Benefit – this states that public expenditure should be incurred if it is

beneficial to the society. This means that authorities should choose items or a
combination of items for public expenditure which collectively maximizes the social
benefits.

4. Principle of surplus-this states that for meeting current expenditures we should have
current revenue. This means the government should not incur budget deficits. It should
have surplus budget so that at times of unprecedented expenditure, the little savings will
make the government to run.

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 5. Principle of sound financial administration- this states that public accounts must be
maintained accurately and systematically and this must be audited in order to
investigate discrepancies.

Any State any other sources of income to the government and show how it
is spend?

4.2.3.1 BALANCE OF PAYMENTS

This is a summary of a country’s international transactions. In other words it is the difference

between the receipts from other countries and payments to other countries within a year.
This suggests that the Balance of Payments deals with the exports and imports of a country and
hence can be divided into two accounts as follows:

a. The current account which shows the balance between exports and imports of
visible and invisible items.
b. Capital account which shows the balance between the receipts and payment
regarding foreign loans and foreign aid.

When total receipts of a country exceed total payment then the

Balance of Payments is said to be in surplus while when total payments to other countries
exceed total receipts, then the Balance of Payments is said to be in a deficit and when
total receipts from other countries are equal to the total payments to other countries, then
the Balance of Payments is in equilibrium.

4.2.3.2 GROSS DOMESTIC PRODUCT (GDP)

This is the total market value of all the finished goods and services in a country in a year. This
means that

a) GDP is monetary measure only since it measures the market value of annual output in a
country
b) Only final goods and included i.e goods and services purchased for final use not for
resale. Thus only goods and services produced and consumed locally are considered.

Thus in view of the above then, the market value of the following is included in GDP of a
country

a) Total agricultural production

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 b) Total mineral production
c) Total industrial production

4.2.3.3 GROSS NATIONAL PRODUCT (GNP)

This is the total market value of all goods and services which generate income in any country.
This means that goods and services sold to other countries and those bought from other countries
are included i.e income from abroad. Therefore,

GNP= GDP + Net Income from abroad (Exports less Import).

LEARNING ACTIVIY

1. List as many as possible your various sources of income

2. Explain any considerations that you use when spending your income

3. Compare your case with a friend

4.2.3 BUDGETING

This is the process of drawing up a detailed quantitative and financial

statement about the expected income and planned expenditure within a specified period. This
means that a budget is a tool for planning about what you expect to receive and how you intend
to spend. It is therefore necessary that an individual, organization or country prepares a budget
regularly for the following reasons:

1. Helps an individual/business/nation to identify the various sources and expected amounts

of income.
2. Helps evaluate performance
3. Helps to management/individual to harmonize decision making process.
4. Helps co-ordinate the activities of the various departments to meet a common objective.
5. Promotes savings and investment habits among individuals, business and the nation.
6. Assists the individual/business/nation to achieve the set aims and objectives within a
stipulated time periods.

However, for these to be met, there is need to understand the main sections of a budget.
Basically, there are two major components of any budget namely

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 1) Income/Revenue component that contains estimates of various sources and the expected
amounts of revenue. It should be noted that the amount of revenue available determines
the level of activities that will take place within the budget period.

2) Expenditure/Expenses component that deals with the outflows of funds i.e expenses
incurred during the budget period. This involves the allocation of the expected income to
various items that are intended to accomplish.

A comparison of the income and expenditures suggests that when the

revenue exceeds expeditions in any budget period then the budget is said to be in surplus, when
the expenses exceed revenues, the budget is said to be in deficit while when the revenue equals
expenditures, then the budget is said to be balanced or otherwise at equilibrium.

Now, let us discuss some budgets that are vital in our daily lives. Basically there are three types
of budgets namely personal, business and national budgets. These are presented as hereunder.

A. PERSONAL BUDGETS
This refers to a budget prepared by an individual specifying the goals and how they are going to
be achieved. For this to be met, the following factors are considered:

1. Sources of income – this includes all the sources of income to an individual eg salaries and
wages from employment, interest on savings, dividends from investments, gifts and donations.

2. Expenses to be incurred – this deals with intended items to spend on and it follows a trend.
First is expenditure on basic needs eg food, shelter, clothing and secondly expenditure on
secondary needs, education, radio, vehicle, furniture etc.

Now, for effective preparation of personal budgets the following should be considered.

a) Aims and objectives should fall within the income bracket.

b) The affected individual should be involved in making the budget.

c) Basic needs should be give preference before secondary needs and other items (leisure,
entertainment).

d) There should be a constant review of the budget since some budget goal may not be
attainable due to unforeseen circumstances eg changes in price.

ILLUSTRATION

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The following is an example of a simple personal budget for 3 months

January February March

Income (1) salary 8,000 8,000 8,000

(2) others 2,000 - 1,200

TOTAL INCOME 10,000 8,000 9,200

EXPENDITURE (1) food 3,000 3,400 3,200

(2) clothing 1,600 - 900

(3) shoes 500 1,800 -

(4) rent 1,200 1,200 1,200

(5)transport 800 800 800

(6)savings 1,800 2,000 1,500

TOTAL EXPENDITURE 8,900 9,200 7,600

NET SURPLUS/DEFICIT 1,100 (1,200) 1,600

BALANCE FROM LAST MONTH 200 1,300 100

BALANCE CARRY FORWARD 1,300 100 1,700

B) BUSINESS BUDGET
This refers to a budget prepared for the business with specific goals and how they are going to be
achieved in the business. Therefore the following are the considerations or essentials of a good
business budget.

1. Co-ordination among departments where all Heads of Departments should be involved.

2. Follows laid down procedure to avoid confusion. This takes the form
a) Preparation of draft budget which has to be forwarded to the relevant authorities for
further discussion and approval.
b) Preparation of final budget after the adjustment and other alterations has been made.
3. Periodic evaluation to monitor the actual performance against the budget plan.
4. Correction of deviations between the actual and the planned performance by taking
appropriate steps.

It is noteworthy at this point that in most businesses, the budget prepared shows the cash
forecasts in terms of income and expenditures and hence are called cash flow budget. The format
is similar to personal budgets presented above.

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 EXERCISE

Use the following extract from the books of Book Point Investment Ltd to prepare a cash flow
budget.

MONTH SALES SALARIES WAGES RENT RAW MATERIALS

JAN 1,500 2,000 3,000 1,000 4,000

FEB 1,800 5,000 1,000 1, 000 8,000

MARCH 20,000 6,000 4,000 1,000 6,000

Discuss the process of preparing the national budget in Kenya.

(c) NATIONAL BUDGETS

A good public budget shows the following

(a) Financial accounts of the previous year

(b) Budget estimates and the revised estimates of the current year

(c) Budget estimates of the coming year that are classified based on two assumptions

i. Current years taxes, their rates and expenditure policy will continue

ii. proposed changes contained in the budget act as a description of the fiscal policy of the
government and the financial plans corresponding to them

Public budgets can be classified based on the recurrent expenditure that are
incurred in meeting obligatory expenses and capital expenditure that are incurred during capital
formation. Such classification takes the form of functional classification or economic
classification.

Functional classification refers to the functions of the government as recommended under the
United Nations and as discussed earlier. This includes the following categories:

1. General services that includes expenditure on defense and basic administrative

structure like tax collection

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 2. Social services that includes expenditure on health, education, Higher Education
Loans Board (HELB) and public libraries

3. Economic services that promote economic activities like agriculture, industry etc

4. Un-allocatable category that includes expenditure which can’t be classified as

above

The economic classification on the other hand classifies expenditure based on the mode of its
financing e.g government transaction in commodities.

However, for preparation of a good public budget, there is need adopt a program and
performance based budgeting system (PPBS).

PPBS: This is based on activities, functions and projects of the

government. It aims at improving formulation and execution of expenditure policy of
the government and serves the purposes:

1. Arises out of scarcity of resources relative to the society needs

2. It goes beyond just a certain project and emphasizes the need for efficiency
and steps followed in achieving projected goals

3. Provides feedback to the executive and the legislature on the outcomes of

decisions made

4. Without appropriate PPBS, there is haphazard tendency to create decisions

In view of the above justification for PPBS, the following stages or steps are thus necessary for
successful PPBS:

1. Definition of goals and objectives of the various policies and measures of the
government

2. Deployment of analytical techniques of the cost benefit analysis

3. Projection of current programs and policies to related future benefits or

problems

Contrary to the expectations of PPBS, there are certain problems

associated with such a system. This includes the following:

1. Multiplicity where a given objective maybe a target of more than one program
and vice versa

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 2. Quantification where it is difficult to quantitatively measure results of some
programs

3. Flexibility where some political system maybe quite flexible to programs which
can’t be quantified and whenever rigid

4. Analytical skills which depends on people who prepare and execute the program.
These skills are usually limited

5. Accounting system where all accounts should be less aggregative for PPBS to
work efficiently since the more aggregative it is, the more the spending.

4.3SUMMARY

In this topic we have learnt about public finance as to deal with pubic revenue and public
expenditure. Public revenue is the income to the government while public expenditure is
government spending. We have also learnt that the government raises funds through taxes, fines,
prices, fees, state properties and borrowing. Moreover, we have learnt that public expenditure is
guided by several principles such as principle of economy, maximum social benefit, surplus and
sound financial administration.

Further, we have learnt that public finance also deals with the balance of payments, gross
domestic product and gross national product. Finally we have discussed budgeting especially
reasons for budgeting and preparation of simple personal budgets. The adoption of Program and
Performance Budgeting System in public budgets has also been discussed.

4.4 SELF CHECK

SELF CHECK 4

1. Explain why the government expenditure has increase significantly in the recent years
(5marks)

2. Explain the effect of the government expenditure with regard to be budget (6marks)

3. Write short notes on each of the following

a) Balance of payments (3marks)

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 b) Gross Domestic Product (3marks)
c) Gross National Product (3marks)

4. Discuss why the Kenyan budget has had a deficit in its Balance of payment and suggest
ways on how it can be improved (10 marks)

4.5 Score Board

Range of marks Level of Performance

25-30 Very good

15-24 Good

11-14 Satisfactory

0-10 Read the topic again

4.6 LEARNING OUTCOMES

You have now completed the topic on public finance, please tick in the column which reflect
your understanding of the various learning outcome listed below.

No. Learning Outcome Sure Not Sure

1. I can now define public finance

2. I can well discuss the functions of the government in a

country

3. I can now identify the sources of income to the

government

4. I can now describe the guiding principles to public

expenditure

5. I Can now differentiate between BoP, GDP and GNP

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 6. I can now explain PPBS

If you have put a tick at the “not sure” column, please go back and study that section in the topic
before proceeding.

If you have ticked “sure” in all the rows in all the columns you are ready for the next topic

Congratulations! You can continue to the next Topic

1.7 FURTHER READING

Musgrave, R. A and Musgrave, P. B. (1978). Public Finance in Theory and Practice. McGraw
Hill. New York

Bhatia, H.L. (1998). Public Finance. Vikas Publishing House. New Delhi.

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 TOPIC FIVE

TAXATION

5.0INTRODUCTION

This topic focuses on the concept of taxation. It introduces you to the principle types of taxes, tax
evasion and suggests remedial measures to tax evasion. Further, the concepts of income tax and
its calculations are discussed.

5.1 OBJECTIVES

By the end of this topic, you should be able to:

1. Differentiate between different types of taxes
2. Describe the principles governing taxation
3. Explain the sources of opportunities for tax evasion and suggest remedial
measures
4. Calculate the income tax of an employee.

5.2SECTIONS OF THE TOPIC

In this topic, we shall cover the following sections:

Section 1: Definition and types of taxes
Section 2: Principles of taxation
Section 3: Tax evasion and its remedial measures
Section 4: Income tax calculations

5.2.1DEFINITION AND TYPES OF TAXES

Recall how we defined a tax in the topic public finance. We said that a tax is a compulsory
contribution imposed on individual to meet the expenses which are incurred for a common
course. This means that a tax has two main characteristics. Firstly it is a compulsory
contribution whereby everybody must pay and secondly there is no direct service against the
payment of tax. This means that despite compulsorily paying the tax, an individual has no
right to demand for services directed to him or her.

Ensuing from this definition is the fact that all the tax income collected is pooled together
before expenditures are done based on the guiding principles discussed earlier under public
expenditure. It should be noted that tax revenue constitutes the highest towards public
revenue in country. This is because of its compulsory nature and the different forms that tax
is manifested. The following are some of the types of taxes:

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 1. income tax- this is tax imposed on income of individuals salaries and other allowances
2. corporate tax - this is tax imposed on profits of public limited companies
3. sales tax- this is tax imposed on sale of commodities and its imposed on businessmen
4. excise tax - this is tax imposed on production of commodities mainly by production
industries
5. Customs duty- this is tax imposed on imports or exports of commodities.

Explain other types of taxes in Kenya.

5.2.2PRINCIPLES OF TAXATION

The concept of taxation and especially the guiding principles have evolved over the years.
Specifically, the first four principles were by an economist Adam Smith while the others were
developed after Adam Smith and are basically expounds on this first four. Let us now explain
each of these principles.

Equality: This state that the subjects of every state ought to contribute towards the support of the
government in proportion to their respective abilities. This means that individuals must
contribute based on their respective abilities. Thus, the more you have the more you ought to
contribute.

Certainty: This states that the tax which each individual is bound to pay ought to be certain and
not arbitrarily. This means that a proper system should be in place such that individual know
their tax obligation.

Convenience: This states that the tax an individual is supposed to pay should be imposed such
that the time and method of payment is convenient to the payer as much as possible. In fact most
taxes are imposed at source such that the payer does not feel it much. For instance income tax is
paid regularly as the income is paid to the person and is usually done by the employer and
remitted to the government. Also, the price of a commodity is inclusive of the relevant taxes.

Economy: This states that since every tax has cost of collection, this cost should be as minimum
as possible. This means that the tax income should always be more than its cost of collection so
as to generate revenue for the government.

Productivity: This principle states that the tax system should be able to yield enough revenue for
the treasury to avoid deficit financing. This means that the tax revenue should always provide
sufficient funds for the government so as mitigate any deficits in its revenue.

Buoyancy: This states that there should be an increase in tax revenue even if there is no change
in tax base. This means that the tax system should have an inherent tendency to increase with
national income even if the tax rates and coverage are not revised.

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Flexibility: This states that authorities should be able to revise the tax structure (coverage and
rates) to suite the changing requirements of the economy.

Simplicity: This principle states that the tax policies should be simple for people to understand
and easy for the government to administer.

Diversity: This principle postulates that there must be different types of taxes so that the tax
burden is on different groups of the society. This is intended to ensure that every person
contributes towards government revenue through payment of tax.

A good tax system is that which fulfills the maximum possible number of
these principles of taxation. Thus an ideal tax system should meet the majority of this principle.

However, the percentage proportion of tax revenue in relation to the Gross Domestic Product in
less developed countries such as Kenya is lower than those in developed countries. This is
primarily because of high tax rates that are intended to raise more funds for the government. This
means that citizens in these countries are taxed heavily and as a result tend to resort to way to
evade paying their tax liabilities by capitalizing on certain loopholes in the tax system.

5.2.3TAX EVASION

What have you been doing to evade paying a debt?

Tax evasion: This is a situation whereby an individual fails to meet his or

her tax liability as required. This is possible by capitalizing on existing short falls in the tax
system as discussed below.

Information gap in all levels: There are inappropriate records that are maintained by businesses
that have tendency to conceal factual evidences in the name of small businesses. Such people
pretend to be running small businesses in order to pay less tax yet they are running larger
businesses.

Complicated tax laws: There have been changing provisions in terms of tax rebates (tax
discounts or waivers) which have been restructured in the form of Value Added Tax through
rationalization. It is thus difficult to tell who to give the tax discount or waiver which at times is

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given on friendly basis. Also the inclusion of VAT in the price of certain commodities is not
clearly understood to an extend that the consumers rarely know which commodities attract VAT
in their cost hence the charge tax is not remitted to the government.

Concealment of true ownership: This creates a loop hole whereby one invests the property in
another person’s name say a relative. This makes it difficult for one to trace the source of funds
for such investments.

Imperfect tax administration: Tax officials are not efficient and like any other human being there
are emanable to temptations leading to corruption. The tax laws are also complicated for people
to understand.

Donation political parties: Any receipts to political parties and other Non Governmental
Organizations (NGO) are not taxed yet it is an income. Their accounts and those of high profile
personality’s are not audited. Also if you pledge loyalty to the ruling party as a business man you
are awarded by not paying tax.
WHAT OTHER OPPORTUNITIES DO YOU THINK EXIST FOR TAX EVASION?

Remedial measures to tax evasion: In order to increase tax revenue,

the government needs to check on the loopholes discussed above. Below are some measures that
can be taken to reduce tax evasion.

1. There is need to have appropriate conceptual definitions of income and put appropriate
tax laws.
2. There is need to reduce incentives for tax evasion and put obstacles to evasion. This can
be achieved by
a. Lowering tax rates so that people earn more hence taxed more.
b. Supplementing income tax with other forms of taxes such as tax on expenditure,
annual income tax etc.
3. There is need to have comprehensive returns on personal accounts.
4. Compulsory auditing of accounts of high income tax payers and assigning code numbers
for each.
5. Donation to political parties to be taxed and all accounts for political parties and other
NGOs to be audited.
6. Penalty for tax evasion should be related to the tax saved rather than the income
concealed. It should also be increased to make it more punitive.

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 7. Adequate attention to be paid to bracket creeping i.e when there is inflation the
government increases salaries of employees to make them get high salary hence pay
more tax.
8. Also tax brackets should be frequently adjusted to take into account of the price raise
factor.

Suggest other remedial measures for tax evasion.

5.2.4 INCOME TAX

Income tax: This is a tax levied on every person who earns an income
from salaries, wages, commissions, interest on bonds and savings, dividends on share etc. now,
before we look at income tax computation, let us first define some basic terms used under it. This
include:

Gross income: this is the total income earned by an individual in a month or year. It consists of
the basic income basic salary and all the allowances due to the individual.

Relief: this is a tax rebate, discount or waiver given to an individual. It takes the form of
personal or family

Taxable pay: Is the gross income less contribution to registered schemes like pensions or
insurance provided that the scheme is registered with the commissioner of income tax.

Tax liability: this is the actual amount of tax paid by an individual. It is obtained by taking the
tax payable less the relief.

Net income: this is the final amount received by an individual after all deductions have been
made. It is also referred to as the take home package and is calculated as

Net income = Gross income-(tax paid +contribution to registered schemes + any other
deduction).

Example1

An employee in a certain company drew the following benefits in the month of April 2011: Basic
salary Kshs. 20,000, House allowance Kshs. 15,000, Medical allowance Kshs. 8,000,
Car allowance Kshs. 8,500, Entertainment allowance Kshs. 5,500 and
Responsibility allowance Kshs. 7,200. During the month the employer made the following
payments: Kshs.430 to NHIF, 5% of basic salary to a registered pension scheme,3 % the basic
salary to the cooperative for shares and Kshs.12,000 to a medical chemist for the drags he had

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taken. In addition an employee received a tax relief Kshs.1, 056. Using the tax schedule below
calculate the employee’s
a) Gross income

b) Taxable pay

c) Tax charged

d) The net income.

Tax schedule

Income (Ksh) tax rate (%)

1-10,800 10%

10,801-21,600 15%

21,601-32,400 20%

32,401-43,200 25%

43,201 and above 30%

Solution

a) Gross income = basic salary + all the allowances received

Basic salary Kshs. 20,000.00
House allowance Kshs. 15,000.00
Medical allowance Kshs. 8,000.00
Car allowance Kshs. 8,500.00
Entertainment allowance Kshs. 5,500.00
Responsibility allowance Kshs. 7,200.00
Gross income Kshs. 64,200.00

b) Taxable pay = Gross income - contribution to registered schemes(pension scheme)

Gross income Kshs. 64,200.00

Less pension scheme (5%of20, 000.00) Kshs. 1,000.00

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Taxable pay Kshs. 63,200.00
c) Tax charged

We use the tax schedule to tax the amount for taxable pay. This is because the deductions
towards registered schemes shall be taxed at the time of payment.

10
1st 10,800= x10,800 = 1,080.00
100

15
2nd 10,800= 10,800 = 1,620.00
100

20
3rd 10,800= 10,800 = 2,160.00
100

25
4th 10,800= 10,800 = 2,700.00
100

30
5th (63,200  43,200)  20,000 6,000.00
100

Total tax =13,560.00

Less Relief = 1,056.00

Tax charged = 12,504.00

d) Net income = Gross income-(tax charged +pension + all other deductions)

Gross income Kshs. 64,200.00

Less pension scheme (5%of20, 000.00) =Kshs. 1,000.00
Tax charged = Kshs. 12,504.00

NHIF = Kshs. 430.00

Medical Chemist = Kshs. 12,000.00

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 Shares (3% of 20,000.00) = Kshs. 600.00 Kshs. 25,534.00

Net income Kshs. 38,666.00

Example 2

An employee draws the following benefits in a month: Basic salary Kshs. 37,650.00, House
allowance Kshs. 36,600.00, Subsistance allowance Kshs. 2,900.00, Car allowance
Kshs. 4,400.00, Responsibility allowance Kshs. 800.00 and a non contributory
medical scheme. In a month the employ contribute 10% of basic salary to a registered pension
scheme, Ksh. 320 to NHIF, 15% of basic salary to cooperative society and 400 to the union for
all employees. The employee is however entitled to a personal relief of Kshs. 1,080 per month.
Using the tax schedule provided calculate above, calculate the employees:

a) Gross income per year.

b) Yearly taxable income
c) Monthly tax charged
d) Net monthly income received

Solution

a) Gross income = basic salary + all the allowances received

Basic salary Kshs. 37,650.00
House allowance Kshs. 36,600.00
Subsistance allowance Kshs. 2,900.00
Car allowance Kshs. 4,400.00
Responsibility allowance Kshs. 800.00
Gross income Kshs. 82,350.00
Gross income per year = Kshs. 82,350.00 p.m X 12 months = Kshs. 988,200.00

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 b) Taxable pay = Gross income - contribution to registered schemes(pension scheme)

Gross income Kshs. 82,350.00

Less pension scheme (10% of 37, 650.00) Kshs. 3,765.00
Taxable pay p.m Kshs. 78,585.00
Yearly taxable income = Kshs. 78,585.00 p.m X 12 months = Kshs. 943,020.00

c) Tax charged

10
1st 10800= x10,800 = 1,080.00
100

15
2nd 10,800= 10,800 = 1,620.00
100

20
3rd 10,800= 10,800 = 2,160.00
100

25
4th 10,800= 10,800 = 2,700.00
100

30
5th (78,585  43,200)  35,385 10,615.50
100

Total tax =18,175.50

Less Relief = 1,080.00

Tax charged = 17,095.50

d) Net income = Gross income-(tax charged +pension + all other deductions)

Gross income Kshs. 82,350.00

Less pension scheme (5%of20, 000.00) =Kshs. 3,765.00
Tax charged = Kshs. 17,095.50

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 NHIF = Kshs. 320.00

Union dues = Kshs. 400.00

Shares (15% of 37,650.00) = Kshs. 5,647.50 Kshs. 27,228.00

Net income Kshs. 55,122.00

EXERCISE

Mrs Olive is a personnel manager with a certain company. She has a basic salary of 26,000 per
month, House allowance 20,000; Substance allowance 2,500; Responsibility 4,000; Car
allowance 8,000 and Medical allowance 5,000. She contributes 10% of basic salary to a
registered pension, 320 to NHIF; 200 to NSSF and 500 for service charge. In addition she pays
1000 to her cooperative society every month and she has a personal relief 1,056 per month.

Required: Calculate

a) Gross income per month and for the whole year.

b) Her monthly and yearly taxable income.

c) Her monthly tax liability.

d) Her monthly tax liability.

e) Her take home package per month.

LEARNING ACTIVITIES

1. List the various measures that you have put in place to maximize your debt collection.

KAFUCO ESM104 GOOD MOMS

2. Calculate your income tax payment from your pay slip

5.3SUMMARY

In this topic we have defined taxation and given various types of taxes. We have also learnt
about the principles guiding taxation in any country such as equality, economy, convenience,
certainty among others. Moreover, we have learnt the loopholes for tax evasion and suggested
their remedial measures.

Finally, we have calculated the income tax of an individual.

5.4 SELF CHECK

SELF CHECK 5

1. Differentiate between tax evasion and tax avoidance (4 marks)

2. Describe any four main tenets of taxation (4 marks)
3. Explain any five measures taken by the Kenya government to increase its tax revenue (10
marks)
4. Mr. Ndegwa, an employee of Cereal Board and Marketing receives a monthly salary of
Kshs. 80,000/= house allowance of Kshs. 35,000/= traveling allowance of Kshs. 15,000/=
(re-imbursed on monthly basis) and entitled to a car allowance of Kshs. 18,000/= which
he has to account for, and a responsibility allowance of Kshs. 18,000/= per month. Mr.
Ndegwa was to pay the following from his monthly remuneration in the month of March
2010.Kshs. 4,000/= pension scheme (registered), Kshs. 320/= NHIF (national Hospital

KAFUCO ESM104 GOOD MOMS

 Insurance Fund), Kshs. 6,000/= Life Insurance Scheme, Kshs. 3,000/= Co-operative
Society Shares and Kshs. 5,000/= House Saving Scheme

Determine:

(i) Tax Liability (Personal Tax Relief being 1,162) (10 marks)

(ii) His net income (2 marks)

5.5 Score Board

Range of marks Level of Performance

25-30 Very good

15-24 Good

11-14 Satisfactory

0-10 Read the topic again

5.6 LEARNING OUTCOMES

You have now completed the topic on taxation, please tick in the column which reflect your
understanding of the various learning outcome listed below.

No. Learning Outcome Sure Not Sure

1. I can now define a tax

2. I can well discuss the principles of taxation

3. I can now identify the various types of taxes

KAFUCO ESM104 GOOD MOMS

 4. I can now describe the loopholes for tax evasion

5. I Can now suggest remedial measures to tax

evasion

6. I can now calculate the income tax of an employee

If you have put a tick at the “not sure” column, please go back and study that section in the topic
before proceeding.

If you have ticked “sure” in all the rows in all the columns you are ready for the next topic

Congratulations! You can continue to the next Topic

KAFUCO ESM104 GOOD MOMS

 TOPIC SIX

INDEX NUMBERS

6.0 INTRODUCTION

This topic focuses on the concept of index numbers as a measure of inflation. It introduces you to
the price index and its computation.

6.1 OBJECTIVES

By the end of this topic, you should be able to:

 Explain the uses of index numbers
 Describe the various types and computation of price indices
 Explain the concept of the stock market

6.2 SECTIONS OF THE TOPIC

In this topic, we shall cover the following sections:
Section 1: Definition and uses of index numbers
Section 2: Types price indices and their calculation
Section 3: Stock market and stock exchange index

These sections are discussed as hereunder.

6.2.1 DEFINITION AND USES

An index is a value that summaries changes in a variable. It is derived by computing a ratio of

two numbers and can be expressed as a percentage. It therefore a series of numbers by which
changes in the magnitude of a phenomenon are measured from time to time. For this to be
performed, we first select the base year as a starting point since other years measurements are
taken against it.

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The common types of indices are price, stock, quantity, cost of living, sales, performance,
production, and wage and business cycle indices. For purposes of this course we shall
concentrate on the price index and briefly consider the stock index

6.2.2 Price indices

This is done by computing the changes in the price of a commodity (ies) over a period of time. It
is used in describing and analyzing inflation i.e they show how the value of money is
appreciating or depreciating accordingly as the price of commodities rise or fall. A rise in the
price usually signifies the deterioration in the money value and vice versa. Now, for the
construction of price indices, the following factors are in taken into consideration:

1. Purpose of the index

2. Selection of the commodities

3. Choice of the base period

4. Choice of the average to be used

5. Choice of proper weights

6. Price quotations

Types of price indices: there are various types of price indices. Some of
them are discussed below.

1. Price Relative Index (PRI): This measures change over time in price of a single commodity.
It is determined by:

pn
PRI = 100 where p n is the price of commodity in the year of analysis and p o is the price of
po
the commodity in the year of reference (also referred to as the base year).

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 Example

Consider the price of sugar for the following years

Year: 2006 2008 2010 2012

Price (Kshs): 70 80 100 110

p n 110
PRI for the year 2012 =  100 157.14 %
po 70

Interpretation: the price of sugar increased by 57.14% during the period

100
PRI for the year 2010 = 100 142.86 %
70

Interpretation: the price of sugar increased by 42.86% during the period

This index is not useful as a measure of cost living because it doesn’t indicate the general
movement in price of commodities.

2. Simple Average Price Relative Index (SAPRI): This considers the price of several
commodities by simple averaging method. It is given by

pn
 po
/n x 100 where n is the number of commodities or items considered.

Example

Year: 2006 2008 2010 2012

Price of sugar (Kshs): 70 80 100 110

Price of bread Kshs): 27 30 35 55

pn pn 110 55
SA PRI = [  ] / nx100 = [  ] / 2 x100 = 180.42%
po po 70 27

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Interpretation: the prices of commodities generally increased by 80.42% within the period.

The index is limited in its usefulness because all items are treated as equally important to the
consumer. However, this is not usually the case since there are consumer differences in terms of
tastes, preferences, etc.

3. Weighted Average Price Relative Index (WAPRI): This is computed as

pn
WAPRI =  Wi /  wix100 where wi is the weight attached to the commodity.
po
This can be say the budget limit or quantity of the commodity that can be bought.

Example

Item price price amount

1998 2002

Sugar 10 15 650

Meat 15 25 500

The WAPRI can be calculated as

15 25
[ 650  500] /(650  500) ) x 100= (181/1150) x 100 = 157.39%
10 15

Interpretation: the prices of commodities generally increased by 57.39% within the period.

4. Simple Aggregate Price Index (SAPI)

This is computed by the formula

p n
100
p o

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 Example

Item price price

1998 2002

Meat 15 25

Sugar 10 15

25 40

SAPI=
p n
100 =
40
100 = 160%
p o 25

Interpretation: the prices of commodities generally increased by 60% within the period.

Disadvantages of SAPI

It treats all items equally yet there are. Consumer tastes and preferences
It is affected by units in which price quotation are based e.g kilogram, litre etc.

5. Weighted Aggregate Price Index (WAPI)

This is calculated as
p n
Wi 100 Where wi is the respective weight of the item.
p o

The weights can be considered as the quantities bought in the reference period and those in the
year of analysis. When the quantities in the reference year (qo) are considered as weights then

the weighted aggregate price index is called Laspeyre’s price index i.e
 p qo x100
n

 p qo
o

When the quantities of the year of analysis (qn) are considered as weights, then the weighted

aggregate price index is called Paasche’s price index i.e

 p qn x100 .
n

 p qn
o

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The square roots of the product of Laspeyre’s index and Paasche’s price index gives the Fishers’

ideal index i.e

 p qo x  p qn x100
n n

 p qo  p qn
o o

Similarly, when the both the base year as well as the current years prices and quantities are
considered may be reconstructed to give very close approximation to results obtained by the
Fisher’s Ideal index. When this is done then the formula is called Marshall-Edgeworth index

and is defined as
 p qn   pnqo x100
n

 p qn   poqo
o

Example

Below are the prices and quantities of selected commodities sold at a certain Kiosk in the years
2000 and 2010.

2000 2010

Commodity Prices (Ksh) Quantity Price (Ksh) Quantity

(Bags) (Bags)
Maize 05 135
20 30
Wheat 95 160
8 7
Beans 150 320
5 8

Using 2005 as the base year, calculate and comment on

(a) Laspeyre’s index

(b) Paascher’s index
(c) Fisher’s ideal index

Solution

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From the question, the price for the commodities in 2000 is po while the quantity is qo. Similarly,
the price and quantity for the year 2010 is pn and qn respectively. Thus the following table is
generated.

Po Qo Pn Qn PoQo PoQn PnQo PnQn

Maize 5 20 135 30 100 150 2700 4050
Wheat 95 8 160 7 760 665 1280 1120
Beans 150 5 320 8 750 1200 1600 2560
1610 2015 5580 7730

Laspeyre’s price index =

 p qo x100 =
n
5580/1610 x 100 = 3.4684 x 100 = 346.84%
 p qo
o

Prices increased by 246.86%

Paasche’s price index =

 p qn x100 = 7730/2015
n
x 100 = 3.8362 x 100 = 383.62%
 p qno

Prices increased by 283.62%

Fishers’ ideal index =

 p qo x  p qn x100 =√ (3.4684 x 3.8362) x100 =364.63%
n n

 p qo  p qn
o o

Prices increased by 264.63%

If prices of all the commodities change in the same proportion then

Paasche and Laspeyres price indices are equal. Therefore the weighting is irrelevant. If quantities
of all goods change in the same ratio, the two indices are equal since the two weighting systems
are relatively the same.

However, in practice neither price nor quantity change in the same ratio and therefore the two
indices can never be equal. This is because price rise makes people buy relatively less of the
items that have become relatively experience. Also, changes in consumer tastes and preference
induce different market adjustment for different goods.

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Paasche price index shows the relative change in cost of purchasing because it uses the reference
period. Therefore it is more realistic as it reflects changes in tastes and real earnings. On the
other hand, Laspeyres price index is less expensive to compute since Paasche price index require
quantities bought in each and every year of analysis.

LEARNING ACTIVITIES

The following table shows commodities sold in a certain supermarket for the years 2009
and 2010.

2009 2010
Commodity Price Quantity Price Quantity

A 200 80 400 60

B 500 100 600 50

C 400 150 500 100

D 200 200 200 150

Using 2009 as base year, Compute:-

(i) Lespeyre’s price index

(ii) Paasche’s price index

(iii) Fisher’s ideal price index

(iv) Marslall-Edgeworth price index

(v) Comment on your results obtained above

6.2.3 STOCK MARKET

This is a market which deals with the exchange of shares of a public quoted companies,
government securities and stocks of municipal authorities i.e it is a market where investors can
buy and/ or sell shares and other securities. Thus the securities traded at the stock market
includes government stocks or bonds, Ordinary shares whose owners are ordinary shareholders
with voting rights and preference shares whose owners are preference shareholders, provide
funds that posses fixed rate of interest and have no voting rights.

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 A share is a unit of owner’s capital in a business while Stock refers to a
bundle (say a minimum of 100 shares) of company’s fully paid-up shares put together.

It is therefore imperative that every country must have a stock market since it plays the following
functions:

1. Provides a ready market for those whose who wish to buy and sell shares.
2. Spreads risks since investors may avoid investing in one company which may go into
liquidation.
3. The stock exchange index serves as a parameter used to measure the country’s economic
progress.
4. Protects the country against fraud because accounts of quoted companies must be
published.
5. Provides useful statistical data that assists the government to evaluate economic
performance of the country.

QUOTED COMPANIES: These are companies whose shares are dealt

with in the stock exchange market. Such companies are usually public Limited Companies
although private Companies may also be quoted provided they go public. Indeed, many
companies strive to get quotation to the stock market because of the following reasons:

1. A Company may raise more capital by floating more shares in the stock exchange
market.
2. A Company may use information from stock exchange to improve its performance.
3. Helps to attract competent personnel into the company
4. The Company will know the value of its shares in the market.
5. Its attractive to investors since its shares are easily transferable
6. Helps promote the image of the Company because quoted Companies are firms that
perform well only.

However, quoted companies have the following disadvantages:

1. A company can be deregistered if it has a poor performance record.

2. It’s expensive to obtain quotation because of paying such fees as audit, brokerage fees
and legal fees.
3. A Company can’t maintain secrets as it’s required to publish its accounts.
4. If creditors lose confidence in the company then it may lead to liquidation.
5. A Company has no control over the incoming shareholders who may use their vote to
influence the company’s policies.

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 Having discussed the stock market, there is need to highlight the factors
that are considered when buying and or selling shares. Below are some of these factors.

1. Nature of product – consider whether to invest in an agricultural, industrial, finance and

banking or alternative investment companies.
2. Performances of the company-consider if the shares of the company are easily
transferable because some poor performance companies do not command high demand
and hence are difficult to convert to cash.
3. Diversification – buy shares in different companies to spread risks and have a wide
product mix.
4. The company growth rate- invests in a company whose growth rate is favorable. This is
seen when a company declares more dividends.
5. Security-invest in guaranteed securities such as those of the government.

Suppose you have participated in the tazama citizen, tazama chapaa programme
and won yourself five million Kenya money and you intend to invest in shares
with either Mumias sugar company, Barclays bank of Kenya, Kenya power and
company or the safaricom company. Discuss with justification where you will
invest your money.

Stock exchange index: this indicates the level of investment in stock

securities. This indices are constructed to measure the general price movement in the listed
shares of a stock exchange. Moreover, stock index is a geometric mean of 20 companies at the
close of business each day. Therefore, to compute this index the following is required:

1. Closing share prices which are multiplied to form the numerator

2. Previous days prices that are multiplied in a similar manner

3. Devide the results in No.1 by the result in No. 2

4. Take the 20th root of the above results (3)

5. Multiply the results by the previous days index to get today’s index

This process is summarized in the formula

Insert formula

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6.3SUMMARY

In this topic we have learnt that an index is a ratio of two numbers expressed as a percentage.
Indices are of different types such as price, stock, quantity, production, and wage and business
cycle indices. Of great importance is price index as it is used in analyzing inflation. We have also
learnt that price indices are either simple or weighted. The weighting takes the form of
expenditure allocation or the quantity of the commodities bought in the base year or the year of
analysis. When the quantities in the reference year are considered as weights, then the weighted
aggregate price index is called Laspeyre’s price index while when the quantities of the year of
analysis are considered as weights, then the weighted aggregate price index is called Paasche’s
price index.

Moreover, we have learnt that stock exchange market provides an opportunity where investors
can buy and/ or sell shares and other securities. Also we have explained the role of the stock
market in the growth of an economy. Further, the merits and demerits of quotation have been
discussed. Finally, we have highlighted the considerations to make before buying and/or selling
shares in a company and provided the formula for calculating the stock index.

6.4 SELF CHECK

SELF CHECK 6
1. Describe any five functions of stock market in the growth of Kenya’s economy (5marks)

2. Explain any four circumstances under which a company may be deregistered from the
stock market (6marks)

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 3. A firm uses five raw materials A, B, C, D, & E in its production process. The table
below relate to the amount and price of each of the raw materials in the base and current
years respectively.

Price per unit (RS) Number of units (Amount)

Base Period Current period Base period Current period

A 8 65 200 1950

B 20 30 1400 1650

C 5 20 80 900

D 10 15 360 300

E 27 10 2160 600

Using the data, compute the following index numbers:

(i) Fisher’s ideal (10 marks)

(ii) Marshall Edgeworth (2 marks)

(iii) Using none of the weights (2 marks)

4. Highlight the main uses of index numbers in an economy (5marks)

6.5 Score Board

Range of marks Level of Performance

25-30 Very good

15-24 Good

11-14 Satisfactory

0-10 Read the topic again

LEARNING OUTCOMES

KAFUCO ESM104 GOOD MOMS

You have now completed the topic on public finance, please tick in the column which reflect
your understanding of the various learning outcome listed below.

No. Learning Outcome Sure Not Sure

1. I can now define an index

2. I can well discuss the uses of index numbers

3. I can now compute the price index of commodities

4. I can now the functions of a stock market

5. I Can now describe the securities traded in the stock

market

6. I can now explain the factors considered when buying

or selling shares

If you have put a tick at the “not sure” column, please go back and study that section in the topic
before proceeding.

If you have ticked “sure” in all the rows in all the columns you are ready for the next topic

Congratulations! You can continue to the next Topic

KAFUCO ESM104 GOOD MOMS

6.7 FURTHER READING

Saleemi, N.A (2000) Business Calculations and Statistics Simplified. Saleemi Publishers,
Nairobi, Kenya

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 ANSWERS TO SELF-TEST QUESTIONS

ANSWERS TO SELF-TEST QUESTIONS

SELF CHECK 1

(a) Ledger accounts

Dr Bank a/c Cr

Date Particulars Amount sh. Date Particulars Amount

sh.

1/1/2011 Capital 2000000 2/1/2011 Premises 800000

15/1/2011 Mumias sugar 400000

31/1/2011 Balance c/d 800000

2000000 2000000
31/1/2011 Balance b/d 800000

Dr Capital a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

31/1/2011 Balance c/d 2000000 1/1/2011 Bank 2000000

2000000 2000000

31/1/2011 Balance b/d 2000000

Dr Purchases (Sugar) a/c Cr

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Date Particulars Amount sh. Date Particulars Amount sh.

4/1/2011 Mumias sug 400000 31/1/2011 Balance c/d 880000

25/1/2011 Mumias sug 480000

888000 880000

31/1/2007 Balance b/d 148000

Dr Premises a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

2/1/2011 Bank 800000 31/1/2011 Balance c/d 800000

800000 800000

31/1/2011 Balance b/d 800000

Dr Mumias Sugar co. (creditor) Cr

Date Particulars Amount sh. Date Particulars Amount sh.

15/1/2011 Bank 400000 4/1/2011 Purchases 400000

25/1/2011 Returns out 6000 25/1/2011 Purchases 480000

30/1/2011 Cash 420000

940000 940000

Dr Sululu (Debtor) a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

5/1/2011 Sales 240000 19/1/2011 Returns in 8000

19/1/2011 Cash 232000

240000 240000

Dr Sales a/c Cr

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Date Particulars Amount sh. Date Particulars Amount sh.

31/1/2007 Balance c/d 680000 5/1/2011 Sululu 240000

22/1/2011 Cash 120000

26/1/2011 Cash 320000

888000 880000

31/1/2011 Balance b/d 680000

Dr Returns in (sales returns) a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

19/1/2011 Sululu 8000 31/1/2011 Balance c/d 8000

8000 8000

31/1/2011 Balance b/d 8000

Dr Returns out (purchase returns) (creditor) Cr

Date Particulars Amount sh. Date Particulars Amount

sh.

31/1/2011 Balance c/d 60000 30/1/2011 Mumias sugar 60000

60000 60000

31/1/2011 Balance b/d 60000

Dr Cash a/c Cr

Date Particulars Amount sh. Date Particulars Amount

sh.

19/1/2011 Mrs Sululu 232000 30/1/2011 Mumias sugar 420000

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22/1/2011 Cash 120000 31/1/2011 Balance c/d 252000

26/1/2011 Cash 320000

672000 672000

31/1/2011 Balance b/d 252000

(b) Trial balance

Account title Dr. (sh.) Cr. (sh.)

Bank account 800000

Capital account 2000000

Premises account 800000

Mumias Sugar co. account 0

Sales account 680000

Purchases returns account 60000

Sales returns account 8000

Cash account 252000

purchases account 880000 . .

2740000 2740000

2. (a)Ledger accounts

Dr Land and Buildings a/c Cr

Date Particulars Amount sh. Date Particulars Amount

sh.

1/1/2011 Bal b/f 150000 31/1/2011 Balance c/d 150000

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 150000 150000

31/1/2011 Balance b/d 150000

Dr Capital a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

31/1/2011 Balance c/d 311000 1/1/2011 Bal b/f 311000

311000 311000

31/1/2011 Balance b/d 311000

Dr Purchases a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

17/1/2011 Creditors 15000 31/1/2011 Balance c/d 15000

15000 15000

31/1/2007 Balance b/d 15000

Dr Motor Vehicle a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

1/1/2011 Bal b/f 120000 31/1/2011 Balance c/d 120000

120000 120000

31/1/2011 Balance b/d 120000

Dr Creditors a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

28/1/2011 Bank 10000 1/1/2011 Bal b/f 400

31/1/2011 Bal c/d 9000 17/1/2011 Purchases 15000

19000 19000

31/1/2011 Bal b/d 9000

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Dr Debtors a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

1/1/2011 Bal b/f 15000 31/1/2011 Bal c/d 17000

19/1/2011 Sales 2000

17000 17000

31/1/2011 Bal b/d 17000

Dr Sales a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

31/1/2011 Balance c/d 8000 19/1/2011 Stock 8000

8000 8000

31/1/2011 Balance b/d 8000

Dr Motor Vehicle repairs a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

25/1/2011 Cash 20000 31/1/2011 Balance c/d 20000

20000 20000

31/1/2011 Balance b/d 20000

Dr Cooperative society (loan) a/c Cr

Date Particulars Amount sh. Date Particulars Amount

sh.

31/1/2011 Balance c/d 100000 7/1/2011 Bank 100000

100000 100000

31/1/2011 Balance b/d 100000

Dr Cash a/c Cr

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Date Particulars Amount sh. Date Particulars Amount
sh.

1/1/2011 Bal b/f 30000 1/1/2011 Cash 10000

13/1/2011 Bank 20000 21/1/2011 Drawings 3000

19/1/2011 Cash sales 6000 25/1/2011 Veh repairs 20000

31/1/2011 Balance c/d 23000

672000 56000
31/1/2011 Balance b/d 23000

Dr Premises a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

10/1/2011 Bank 70000 31/1/2011 Balance c/d 70000

70000 70000

31/1/2007 Balance b/d 70000

Dr Bank a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

1/1/2011 Cash 10000 10/1/2011 Premises 70000

7/1/2011 Coop loan 100000 13/1/2011 Cash 20000

25/1/2011 Creditors 10000

31/1/2011 Balance c/d 10000

110000 110000
31/1/2011 Balance b/d 10000

Dr Drawings a/c Cr

Date Particulars Amount sh. Date Particulars Amount sh.

21/1/2011 Cash 3000 31/1/2011 Bal c/d 3000

3000 3000

KAFUCO ESM104 GOOD MOMS

31/1/2011 Bal c/d 3000

(a) Trial balance

Account title Dr. (sh.) Cr. (sh.)

Bank account 10000

Capital account 311000

Motor Vehicle account 120000

Premises account 70000

Land and Buildings account 150000 8000

Sales account 60000

Debtors account 17000

Creditors account 9000

Purchases returns account 8000

Motor Veh repairs account 20000

Cash account 23000

Cooperative loan 100000

Drawings account 3000

Purchases account 15000 . .

428000 428000

SELF CHECK 2

1(a) John’s Trial Balance as at 31st December 2008

Details Dr. Cr.

Capital 250,000

Opening Stock 25,000

KAFUCO ESM104 GOOD MOMS

Plant & Machinery (cost) 250,000

Motor Vehicle (cost) 80,000

Provision for depreciation

Of plant & machinery 20,000

Provision for depreciation

Of motor vehicles 16,000

Purchases 360,000

Sales 600,000

Sales Returns 40,000

Purchases Returns 20,000

Wages & Salaries 60,000

Discount allowed 5,000

Discount Received 4,000

Carriage inwards 2,500

Carriage outwards 3,000

Rent & Rates 15,000

Water& electricity 8,600

Postage & Telephone 7,500

Bad debts written off 1,500

Provision for bad debts 1000

General expenses 8,500

Debtors 55,000

Creditors 46,600

Cash at hand 6,000

Cash at bank 30,000 . .

957,600 957,600

KAFUCO ESM104 GOOD MOMS

 (b) John’s Trading, Profit & Loss Account for the year ended 31st 2008

Shs. Shs.

Sales 600,000

Less Return Inwards 40,000 560,000

Opening Stock 25,000

Purchases 360,000

Less Return Outwards 20,000

340,000

Add carriage inwards 2,500 342,500

367,500

Less Closing stock 22,500 345,000

Gross Profit 215,000

Discount received 4,000

219,000

Less Expenses

Wages 60,000

Discount allowed 5,000

Carriage outwards 3,000

Postage & telephone 7,500

Water & electricity charges

Paid 8,600

Accrual 400 9,000

Bad debts 1,500

General expenses 8,500

Rent & Rates

KAFUCO ESM104 GOOD MOMS

Paid 15,000

Add accrual 3,000

18,000

Less prepaid rates 1,000 17,000

Depreciation

Plant &Machinery 25,000

Vehicles 16,000 41,000

Net Profitc/d 66,500 . .

219,000 219,000

(c)John’s Balance sheet as at 31/9/2008

Fixed Assets Kshs Kshs. Kshs

Plant & Machinery 250,000
Provision for dep. (20,000+25,000) 45,000
205,000
Motor Van Cost 80,000
Provision for dep. (16,000+16,000) 36,000
480,000
253,000

Current Assets
Closing stock 22,500
Debtors 55,000
Less Provision for bad debts (1000) 1,000
54,000
Add Prepaid Rates 1,000
Cash at Bank 30,000
Cash at Hand 6,000
113,500
Less Current Liabilities

KAFUCO ESM104 GOOD MOMS

Creditors 46,600
Accrued Rent 3,000
Accrued electricity expenses 400
50,000
63,500
316,500
Financed by:
Capital 250,000
Add Net Profit 66,500
316,000

SELF CHECK 3

1. (i) Tn= a+ (n-1)d where a=8500, d=2650 and n=10

T10= 8500 + (10-1)2650 =8500+9 2650 =8500 +23950 =32, 350

(iii) Sn =n/2(2a+ (n-1)d)

Sn =10/2 8500+(10-1)2650)=5(17000+23850)=Kshs249,250

2. P= = =2.7880

taking anti logs we get P=Kshs. 613.80

3. YR 1 original cost 15000

10/100 15000 =1500

Original cost 15000

By end of YR 1 10/100 15000 = 1500

13500

Yr 2 10/100 13500 = 1350

KAFUCO ESM104 GOOD MOMS

 By end of year 2 12150

Yr 3 10/100 12150 = 1215

By end of year 3 10945

Yr 4 10/100 1215 = 1093.50

By end of year 4 9841.50

4. Tn= a+ (n-1)d with a=sh.32,500 and n=21

Thus 7,500=32,500+(21-1)d =32,500+20d

20d=7,500-32,500=-25,000

Therefore d= =-1,250, Hence d=sh. 1,250

Depreciation=sh. 1,250 per year.

Alternatively, using depreciation formula presented in topic one as

Thus D= = 1,250

SELF CHECK 4

1. REASONS FOR INCREASED GOVERNMENT EXPENDITURE

a) Increase in population

b) High price levels

c) Increase in provision of social services

d) Demographic form of the government

2. EFFECT OF GOVERNMENT EXPENDITURE

a) Production i.e either directly through expenditure in nationalized industries and

development projects that results in increased national income or indirectly where
the government spends on peace and stability that result in high investments

KAFUCO ESM104 GOOD MOMS

 b) Distribution of income where the government increase tax on rich people and the
income is used to provide services to the poor

c) Economic stability where durng inflation, expenditure reduces and during

deflation expenditure increases

3. SEE TOPIC IN MODULE

4. SOLUTION TO BUDGET DEFICITS

A) RESTRICT IMPORTS

B) EXPORT PROMOTION RESERVES

C) SEEKING FINANCIAL ASSISTANCE

D) CURRENCY DEVALUATION

E) UTILIZING THE COUNTRY’S FOREIGN

SELF CHECK 5

1. TAX EVASION IS A LEGAL PRACTICE SINCE ONE CAPITALIZES

ON EXISTING LOOPHOLE IN THE TAX SYSTEM WHILE TAX
AVOIDANCE IS COMPLETELY AN ILLEGAL PRACTICE

2. SEE PRINCIPLES OF TAXATION

3. See remedial measures to tax evasion

4. Gross income= sh. 166000, taxable pay= sh. 162000, tax charged=sh.43200, tax paid=
sh.42038, total deductions= sh.60358, Net income = sh.105642

SELF CHECK 6

1. See module

2. See disadvantages of quoted companies

KAFUCO ESM104 GOOD MOMS

 3. NOTICE THAT YOU HAVE BEEN GIVEN THE PRICES AND THE
AMOUNT FOR EACH PERIOD NOT THE QUANTITY. WE NEED TO
FIRST FIND THE QUANTITIES FOR THE RESPECTIVE PERIODS BY
DIVIDING THE AMOUNT BY THE PRICE FOR EACH COMMODITY.
THUS THE FOLLOWING COMPUTATIONS WILL BE OBTAINED.

Using the data,

(i) Fisher’s ideal index

Laspeyre’s price index =

Base Current
Po Pn amount amount QO Qn PoQo PoQn PnQo PnQn
A 8 65 200 1950 25 30 200 240 1625 1950
B 20 30 1400 1650 70 55 1400 1100 2100 1650
C 5 20 80 900 16 45 80 225 320 900
D 10 15 360 300 36 20 360 200 540 300
E 27 10 2160 600 80 60 2160 1620 800 600
70 140 4200 3385 5385 5400

 p qo x100 =
n
5385/4200 x 100 = 1.2821 x 100 = 128.21%
 p qo o

Paasche’s price index =

 p qn x100 = 5400/3385
n
x 100 = 1.5953 x 100 = 159.53%
 p qn
o

Hence Fishers’ ideal index =

 p qo x  p qn x100 =√ (1.2821 x 1.5953) x100 =143.02%
n n

 p qo  p qn
o o

(ii) Marshall-Edgeworth index

 p qn   pnqo x100 = 5400  5385 x100 = 10785 x100 =142.19%

n

 p qn   poqo
o 3385  4200 7585

(iii) Using none of the weights

p n
100 =
140
100 =200%
p o 70

4. see module

KAFUCO ESM104 GOOD MOMS

KAFUCO ESM104 GOOD MOMS
REFERENCES

1. Deakin B.E. and Maher W.M(1987): Cost Accounting, 2nd Ed. U.S.A.

2. Ferries R. Kenneth (1993): Financial Accounting and Corporate Reporting, 3rd Ed.
Irwin

3. Mullings G.F and Shao P.S (1979) Mathematics for Management and Finance gage
publishers, Canada

4. Slater R. and Curwin, J(2002):Quantitative Methods for Business Decisions, 5th Ed.
Thomson

5. Syme G.E (1997): Accounting I Prentice-hall, of Canada, Ontario.

6. E-journals and the internet

7. Musgrave, R. A and Musgrave, P. B. (1978). Public Finance in Theory and Practice.

McGraw Hill. New York

8. Bhatia, H.L. (1998). Public Finance. Vikas Publishing House. New Delhi.

9. Saleemi, N.A (2000) Business Calculations and Statistics Simplified. Saleemi Publishers,
Nairobi, Kenya

KAFUCO ESM104 GOOD MOMS

APP

APPENDIX

MODULE EVALUATION

Dear Learner,

We hope you have enjoyed reading this module. In order for us to be able to improve on the
module kindly take a few minutes of your valuable time and answer the following questions.
You are assured that your comments will be taken seriously in improving this module. You do
not have to write your name.

Kindly submit this evaluation form at the centre or at the university when you come for tutorials.

1. Is the module layout clear YES( NO(

If no, give
suggestions----------------------------------------------------------------------------------------------
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2. Is the course outline clear and in line with the course content YES( NO(

3. Does the table of contents indicate the correct page in the module YES( NO(

4 Are the icons/symbols in the correct place in the module YES ( NO(

5. Give specific comments on the following in the module by ticking

CLEAR ( or NOT (

a) Introductions CLEAR ( NOT CLEAR(

b) Readability of the content CLEAR ( NOT CLEAR(
c) Illustrations/diagrams CLEAR( NOT CLEAR (

KAFUCO ESM104 GOOD MOMS

 d) Self-Checks CLEAR( NOT CLEAR (
e) Answers for Self-Checks CLEAR( NOT CEAR(
f) Is the language used in the module CLEAR( NOT CEAR(

6 Does the module have further reading? YES( NO(

If yes, are they relevant, and accessible

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7. Give any other comments you find

necessary---------------------------------------------------------------------------------------------------------
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THANK YOU

KAFUCO ESM104 GOOD MOMS