TOPIC 1: SOURCE DOCUMENTS AND BOOKS OF ORIGINAL ENTRY

CONTENTS

 Source documents
 Books of original entry
 The petty cash book
 Analysis cash book

SOURCE DOCUMENTS

A source document is any document from which information recorded in the books of accounts
is extracted.

Source documents serve as evidence that the transaction being recorded actually took place

Types of source documents

a) Cash receipt

This is a document that serves as evidence that cash has been received or paid out. Used as a
source document when making entries in the cash books.

Normally prepared in duplicate. The original is issued to the person paying the money while a
copy is retained by the receiver of the money.

A cash receipt may not be issued when payment is made by cheques since a cheque is in itself is
a source document.

b) Invoice

An invoice acts as evidence that a credit transaction has taken place.

It is sent by the seller to the buyer demanding payment for goods supplied on credit.

An invoice is prepared in duplicate. A copy is retained by the sender

(Give an example of an invoice)

c) Debit note

This is a document sent by the seller to the buyer to inform him that the amount he owes the
seller has been increased. It is used to correct undercharges in the invoice.

It is regarded as an additional invoice since it increases the amount already invoiced

(Give an example of a debit note)

d) Credit note

This is a document sent to buyer by the seller to inform him that the amount he owes the seller
has been reduced. It therefore corrects overcharges in the invoice.

(Give an example)

e) Payment voucher

A document used as evidence of payment in cash. Used in circumstances where receipts cannot
be issued e.g. in organisations with numerous workers. To be valid, it has to be signed by the
person receiving the money.

f) Statement of account

This is a statement which is sent by a seller to a buyer to show the transactions which have
taken place between them over a given period of time. It is intended to remind the buyer about
the amount of money he owes the seller

BOOKS OF ORIGINAL ENTRY

These are books where transactions are recorded before being posted to the ledger

They are also known as subsidiary books, day books, books of prime entry, diaries or journals. In
this topic, these books will be referred to as journals.

The act of recording information in these journals is known as journalizing

The main books of original entry include:

 The sales journal

 The sales returns journal
 The purchases journal
 The purchase returns journal
 Cash receipts journal
 Cash payments journal
 The general journal

Information recorded in these journals is obtained from the source documents discussed earlier
 a) The sales journal

This journal is used to record only credit sales. When goods are sold on credit, an invoice is sent
to the buyer to demand for payment. The invoice is therefore the source document.

Date Details Invoice number Folio Amount

(Illustration)

The information in the sales journal can be posted to the relevant ledger accounts

b) The sales returns journal

This journal is used to record the value of goods returned to the business by customers who
had bought them on credit. When goods are returned to the seller, a credit note is sent to the
buyer to reduce his indebtness. The credit note therefore is the source document.

Date Details Credit note Folio Amount

number

(Illustrations)

c) The purchases journal

This journal is used to record credit purchases. When goods are bought by the business on
credit, an invoice is sent by the supplier to the business to demand for payment for the goods,
this document becomes the source document for the purchases journal

Date Details Invoice number Folio Amount

(Illustration)

d) The purchase returns journal

This is a journal that is used to record the value of goods the business returns to its suppliers.
When a business returns goods to its suppliers, its issued with a credit note to reduce its
indebtness, the credit note therefore becomes a source document for the purchase returns
journal.
 Date Details Credit note Folio Amount
number

(Illustration)
e) The cash receipts journal

This is a journal that is used to record transactions which involve the flow of cash into the
organisation. When cash is received by the business, a receipt is issued. The receipt therefore
becomes the source document.

Date Details Receipt Folio Discount Cash Bank

number allowed

(Illustration)

f) Cash payments journal

This is a journal that is used to record transactions involving cash outflow from the business.
When money is paid by the business, the cashier issues the receiver with a payment voucher,
this voucher becomes the source document

Date Details Receipt Folio Discount Cash Bank

number received

(Illustrations)

g) The general journal(journal proper)

This journal is used to record transactions involving non trading activities such as sale and
purchase of fixed assets

Date Details Folio Debit Credit

Uses of the general journal

  Recording credit purchases and sales of fixed assets
 Correcting errors made in the ledger accounts
 Recording closing and opening entries of a business
 Recording the settlement of debts using fixed assets
 Recording transfer of debts
 It is used to record the issue of shares

(Illustrations)

Uses of journals

 To relieve the ledgers of too many details

 Journals provide more information than what is provided in ledgers therefore they can
be used for reference
 They are prepared and maintained by different people hence minimizing the chances of
errors and fraud
 They facilitate tracing of errors
 They contain information useful in preparing control accounts

Advantages of journals

a) Helps one to know the account to be debited and credited

b) Reduces the over use of ledgers
c) They allow division of labour since they are prepared by different people
d) They are used as a reference
e) Minimizes fraud because they are prepared by different people
h) The petty cashbook

The word petty means small. Petty cash therefore refers to money set aside to be used in
making payments that require little amounts of money; such as cleaning, postage, stationery
etc.

As the business expands, number of transactions increases hence there is need to relieve the
main cashbook of its bulkiness. To do this, a petty cashbook is opened to record transactions
involving small payments.

The petty cashbook is under the responsibility of a special employee known as the petty cashier
whereas the main cashbook is the responsibility of the general or main cashier. The money the
petty cashier uses is obtained from the main or general cashier.

Receipts L.F Date Details Voucher Total Analysis

number columns
The petty cashbook has two sides-the debit and the credit side. Receipts from the main cashier
are recorded on the debit side while payments are recorded on the credit side. Payments are
further recorded under the analysis columns

Analysis columns are normally given by the examiner. Any expense without an analysis column
is recorded under miscellaneous

Petty cash book with the imprest system

The term imprest refers to the amount of money given to an officer in an organisation to spend
on behalf of the organisation which he later accounts for.

The imprest system is where the money spent by the petty cashier after a specific period of
time is refunded by the main cashier to restore the balance existing at the beginning of the
period (cash float)

(Illustrations)

i) Analysis cash book

This is a cashbook that is used to analyse items of frequent occurrence

The analysis cash book has two sides-the debit and the credit sides. The debit side records all
receipt while the credit side records all payments

(Illustration)

TOPIC 2: FINANCIAL STATEMENTS

CONTENTS

 Introduction
 Concept of trading period
 Determination of profit or loss
 The balance sheet
 Basic financial ratios

INTRODUCTION

The purpose of any business is to make profit though at times, losses may arise. To determine
the amount of profit/losses made, proper accounting records are prepared. These accounting
records also enable the business to determine its financial position. These accounting records
are known as financial statements.

Financial statements prepared by the business therefore include:

 The trading account

 The profit and loss account
 The balance sheet

THE CONCEPT OF THE TRADING (ACCOUNTING) PERIOD

The trading period refers to that period of time that elapses before a business calculates its
profits/losses and determines its financial position. This period can be one month; two months
etc. normally this period is 1 year for most businesses.

At the end of the trading period therefore, the following will take place

 All ledger accounts are balanced

 A trial balance is extracted
 Profits and losses are determined
 A balance sheet is prepared

DETERMINATION OF PROFIT OR LOSS

Businesses buy or produce the goods and services they sell. The price at which they buy or
produce these goods is known as the cost price. The difference between the cost price and the
selling price is the gross profit or gross loss. Profits/losses can be classified into two;

 Gross profit/loss
 Net profit/loss
a) Gross profits

Gross profit refers to the difference between the cost price and the selling price. When the cost
price exceeds the selling, the difference is a loss but when the selling price exceeds the cost
price, the difference is profit.

To determine gross profit, a statement known as a trading account is prepared.

The trading account

This is a statement which is prepared to determine gross profit/loss. A trading account is

therefore an account prepared at the end of the trading period in which gross profit or gross
loss is prepared.
In the trading account, sales are recorded on the credit side while cost of sales is recorded on
the debit side. The difference between the two is gross profit/loss.

To arrive at net sales and cost of sales, the following adjustments are made:

a) Returns inwards

These are goods that are returned to the business by customers to the business. They are also
known as sales returns. Returns inwards are usually subtracted from sales to arrive at net sales.

b) Returns outwards

These are goods are returned by the business to the suppliers. They are also known as purchase
returns. Returns outwards are subtracted from purchases to arrive at net purchases

c) Carriage inwards

This is the cost incurred in transporting goods to the business from the supplier. They are also
called carriage on sales. Carriage inwards are regarded as part of purchases hence they are
added to purchases when calculating gross profit or loss.

(Format and Illustrations)

Uses of the trading account

 Determines gross profit/loss

 Determines the cost of goods available for sale
 Aids in the calculation of margin and mark-up
 Aids in the calculation of the rate of stock turnover
 Determines cost of sales
 Reveals volume of sales
 Comparing performance between periods
 Facilitates the preparation of the profit and loss account
b) Net profit or net loss

This is the difference between expenses and the sum of gross profit and revenue i.e.

Net profit/loss = gross profit + revenues – expenses

When expenses exceed the sum of gross profit and revenues, a net loss is made. But when
expenses are less than the sum of gross profit and revenue, a net profit is made.

The profit and loss account

This is a statement which is used to determine net profit/loss. In the profit and loss account,
gross profit and revenues are credited while expenses are debited. The balancing figure is the
net profit/loss.

A gross loss is regarded as an expense and therefore is debited in the profit and loss account.

(Format and Illustrations)

TREATMENT OF SPECIAL ITEMS

a) Bad debts

The bad debts are subtracted from debtors or treated as a current liability in the balance sheet
and treated as an expense in the profit and loss account

b) Depreciation

The amount of depreciation is subtracted from the respective asset in the balance sheet and
treated as an expense in the profit and loss account

c) Provisions

On creation, they are subtracted from the respective item in the balance sheet and treated as
an expense in the profit and loss account

On increase, the increase is deducted from the respective item in the balance sheet and treated
as an expense in the profit and loss account

On decrease, the increase is added to cash in the balance sheet and treated as income in the
profit and loss account.

Uses of the profit and loss account

 Shows the revenues earned and all the expenses incurred

 Determines net profit/loss
 Helps in calculating the amount of tax to be paid
 Helps employees to determine whether the business is in a position to pay them
 Enables lenders determine whether the business is able to pay them
 Used by managers and owners to make management decisions
 Aids in the calculation of the rate of return on capital and other profitability ratios

Trading profit and loss account

This is a statement that combines both the trading account and the profit and loss account. It is
used to calculate both the gross profit/loss and the net profit/loss

(Illustrations)

THE BALANCE SHEET

A balance sheet is prepared after the trading profit and loss account has been prepared in order
to show the financial position of the business. A “T” format is normally used when preparing
the balance sheet.

Adjustments however have to be made on capital for the following items

 Net profit is added to capital

 Net loss is subtracted from capital
 Drawings are subtracted from capital
 Additional investments are added to capital

Types of capital

a) Capital owned(invested)

This is the owner’s claim in the business. It is calculated as follows:

Capital owned = owner’s contributions + profits – losses – drawings

b) Borrowed capital

This refers to other people’s claims in the business. It is calculated as follows:

Borrowed capital = short term liabilities + long term liabilities

c) Working capital

Refers to the resources available in the business that can be used to immediate obligations. It is
the excess of current assets over current liabilities

Working capital = current assets – current liabilities.

d) Capital employed

This refers to resources that have been generated from long term sources.

Capital employed = capital invested + long term liabilities

OR
Capital employed = total assets – current liabilities

OR

Capital employed = total fixed assets + working capital

(Illustrations)

Uses of a balance sheet

 Enables financiers to determine whether the business is able to meet their claims
 Shareholders use it to determine whether their funds are properly invested
 Helps the government for taxation purposes
 Shows the financial position of the business
 Determines the capital structure of the business
 Aids in the calculation of the rate of return on capital
 Potential investors use it to make decisions on whether to buy shares in the business
 Helps management in comparing performance between different periods
 Enables prospective business buyers make decisions on whether to buy the business.

BASIC FINANCIAL RATIOS

A ratio is an expression of one item in relation to another. Ratios are used to reflect the finer
details of the financial status of the business; hence they are used for planning purposes

Basic financial ratios include:

 Mark-up
 Margin
 Current ratio/working capital ratio
 Rate of stock turnover
 Return on capital
 Acid test ratio/quick ratio
a) Mark-up

This is gross profit expressed as a fraction, a ratio or percentage of the cost price.

Mark-up = Gross profit ÷ cost of sales

(Illustration)

Mark-up helps the business determine satisfactory selling price that will yield enough gross
profit that can cover all expenses and leave a reasonable net profit.
 b) Margin

This is gross profit expressed as a ratio, fraction or percentage of sales.

Margin = Gross profit ÷ Sales
Just like mark-up, margin is also used to determine selling prices.

(Illustrations)

Uses of mark-up and margin

• Helps in setting selling prices of goods

• Can be used in the calculation of profits or losses

• Used in determining sales and cost of sales for a given period of time

Relationship between mark-up and margin

Since mark-up and margin relate to the same gross profit, it means they are related to one
another. Therefore given margin, we can get mark-up and vice-versa. This is done by
subtracting the numerator of margin from its denominator to get mark-up. For example if
margin is ¼, mark-up will be 1/ (4-1) = 1/3. Alternatively if mark-up is 1/3, then margin is 1/
(3+1) = ¼

(Illustrations)

c) Current ratio/working capital ratio

Refers to current assets expressed as a ratio, fraction or percentage of current liabilities

Current ratio/working capital ratio = current assets ÷ current liabilities

Uses of current ratio

 Shows whether the business is in a position to meet its short term obligations when
they fall due
 Helps in assessing whether the business is utilizing its resources fully

N/B: For the business to be in a position to meet its short term obligations, the current ratio
should be more than 1

(Illustrations)

d) Rate of stock turnover(R.O.S.T.O)

The term turnover refers to the net sales

Rate of stock turnover also known as stock turnover ratio, refers to the speed at which stock is
bought and sold within a given period in the business

It is calculated by dividing the cost of goods sold by the average stock

R.O.S.T.O = cost of goods sold ÷ average stock

AND

Average stock = (opening stock + closing stock) ÷ 2

Uses of rate of stock turnover

 Determines slow and fast moving stock

 Used to compute gross profit/loss

(Illustrations)

e) Return on capital

This is net profit expressed either as a fraction, ratio or percentage of capital invested.

Return on capital = Net profit ÷ capital invested

Uses of return on capital

 Compares performance of the business with others

 Compares the performance of the business between different periods
 Shows whether business finances are well invested
 Helps investors make decisions as to whether to invest

(Illustrations)

f) Acid test/quick ratio

It is given by

Acid test/quick ratio = (current assets – stock) ÷ current liabilities

This ratio enables the business determine whether it can meet its current liabilities as and when
they fall due.

(Illustrations)
Importance of financial ratios

a) They summarize numerous financial information in a form that can be understood

b) They make the evaluation of the performance of the business easier
c) They make it possible to determine trends and hence facilitate better management and
investment decisions
d) They facilitate the assessment of business efficiency
e) They facilitate forecasting, planning and budgeting
f) They reveal the strengths and weaknesses of the business to facilitate decision making

TOPIC 3: MONEY AND BANKING

CONTENTS

 Introduction
 barter trade
 money system
 banking

INTRODUCTION

Money: Money refers to anything that is generally accepted as a medium of exchange for
goods and services. Money is in the form of notes and coins.

Banking: Banking refers to all activities carried out by financial institutions involving money.
Financial institutions include the central bank, commercial banks and non-banking financial
institutions.

BARTER TRADE

Barter trade is a system of trade where goods and services are exchanged with other goods and
services. This is a system of trade that was used in African traditional societies though barter
trade is still used in modern societies e.g. where a person works in exchange for food stuffs.

Merits of Barter trade

 Buyers and sellers are able to get immediately those goods and services they require
 Enables a country or person dispose off its surplus
 Promotes harmony, peace and understanding among trading partners
 Promotes specialization in production
 Promotes the standard of living of those involved in trade

Limitations of Barter trade

Despite the advantages mentioned above, barter trade has a number of drawbacks as discussed
below

a) Requires double coincidence of wants

For barter trade to take place there must be double coincidence of wants. This means, that
there must be somebody who has what you have and is in need of what you have for barter
trade to take place. E.g. if someone has a goat and wants beans, then he has to look for
someone who has beans and is in need of a goat. This situation is very difficult to come by.

b) Lack of standard measure of value

In barter trade, it is difficult to determine how much of a commodity should be exchanged for
another. For example if someone has fish and is need of a cow, it will be difficult for him to
determine the number of fish to exchange for one cow.

c) Indivisibility of some commodities

Some commodities cannot be subdivided into small quantities without loss of value. For
example if you have a cow and you want one tin of maize, it will be difficult to subdivide a cow
into smaller parts equivalent to one tin of maize.

d) Perishability of commodities

Some commodities will go bad before they reach the market resulting in losses to the seller.

e) Inconvenience in transporting some commodities

Some goods are too bulky to be carried from one place to another. This will greatly hinder
trade.

f) Lack of standard of deferred payment

It is difficult to make payment in future using goods since their value could have reduced or
needs of the person to be paid could have changed

g) Lack of unit of account

It is difficult to calculate the value of goods and keep a record for future reference

h) Hinders specialization

Lack of double coincidence of wants makes people produce as many products as possible in
order to satisfy market demand
 MONEY SYSTEM

Because of the many drawbacks, barter trade is no longer used; instead it has been replaced by
money system of trade

Development of money

a) The earliest form of money was commodity money which consisted of various
commodities such as ivory, salt, beads, hides and skins. Commodity money had several
limitations which include the following:
 Some commodities were perishable
 Some commodities were not portable
 Some commodities could be obtained easily without effort
 Some commodities were indivisible
b) Because of the above limitations, commodity money was replaced with metallic money
which was in the form of copper, silver and gold. Metallic however had the following
limitations:
 They were insecure to keep and carry around due to their high value
 They were heavy to carry around
 There were not easy to divide
c) The above limitations led to the metallic money being replaced with paper money
(paper notes) which was issued by goldsmiths and silversmiths who provided safe
custody of precious metals. Paper money had the following limitations:
 Fake notes came into existence
 Paper money lacking a legal force (backing by the law)
 Lack of credibility of the issuing authority
d) Paper money was followed by the development of legal tender currency notes and coins
which had the backing of the law. Legal tender currency were issued in the form of bank
notes and coins
e) The need for convenience has given rise to representative and plastic money.
Representative money are in form of cheques, money orders, bills of exchange etc.
whereas plastic money is in the form of credit cards

Forms of money

 Commodity money
 Metallic money
 Paper notes
 Bank notes
 Coin money
  Bank deposits (money held in current accounts)
 Quasi money e.g. cheques, bill of exchange, credit cards, money orders, postal orders
etc.

Characteristics of money

For any commodity to be accepted as money, it must have the following characteristics

a) Acceptability

Money must be generally accepted by everyone as a medium of exchange for goods and
services

b) Divisibility

Money should be easy to subdivide into smaller units (Denominations) without losing its value.
This will enable people carry out transactions with ease.

c) Portability

Money should be light and not bulky in order to be carried around without difficulties.

d) Durability

Money should be able to stay for long without getting torn, defaced or losing its shape and
texture. The material used to make money should therefore be able to withstand tear and
wear.

e) Stability

Money should be able to last for a long time without fluctuating in value.

f) Homogeneity

Money of the same denomination should be uniform in quality and therefore identical. This
makes it more recognizable and hence acceptable

g) Cognisability

Money should be ease to recognize such that it is easy to differentiate between fake and
genuine money.

h) Scarcity
Money should be relatively scarce in supply inoder to retain its value. This is because if money
is abundant in supply, it will lose its value greatly.

i) Malleability

The material used to make money especially coins should be ease to cast into different shapes

j) Not easy to forge

The material used to make money shouldn’t be easily available. The technique used in making
money should also be highly secretive in order to avoid forging

Functions of money

The following are the roles played by money in the economy

a) Medium of exchange

Money enables trade to take place as it is exchanged for various goods and services

b) Measure of value

Money provides a common denominator in which the value of various goods and services are
expressed. For example 1kg of sugar is valued at Ksh 140.

c) Unit of account

Money provides a method through which the value of various commodities is calculated and a
record kept. For example, land can be measured and its value recorded in terms of money.

d) Store of value

Money can be used as a means of storing wealth. This is done by saving money which can be
used in the future to buy different commodities.

e) Standard of deferred payment

Money can be used to settle debts at any time because it is generally accepted as a medium of
exchange for goods and services.

f) Transfer of immovable assets

Immovable assets can be sold and the money realized used to buy similar assets elsewhere.

Demand for money (liquidity preference)

Demand for money refers to the desire of people to hold on money without intending to spend
it. This desire is influenced by three motives (reasons):

 The transaction motive

 Precautionary motive
 Speculative motive
a) The transaction motive

Refers to holding money in order to meet daily expenses such as buying food, paying for
transport etc. one therefore has to ensure that he has money at all times to meet these daily
expenses. Such moneys are held for transaction motives.

The amount of money held for transaction motive will depend on the following factors:

 Individual level of income: A person who earns more will have more money at his
disposal hence he will hold more money to meet daily transactions as compared to
someone with a low income
 Interval between pay days: When the interval between paydays is far apart, more
money will be held unlike when the interval is short. For example, a person who is paid
after a month need to hold more money to meet daily expenses for the whole month
unlike a person who is paid daily.
 Spending habits: High spenders will hold more money as compared to low spenders.
This is because they need more money to satisfy their spending habits
 Prices of commodities: When prices are high, people will require more money in order
to meet their daily expenses unlike when prices are low
 Availability of credit: When people are not allowed to buy on credit, they will need
more money to meet their daily expenses unlike when credit facilities are allowed

The transaction motive can further be subdivided into income motive and business motive.
Income motive refers to holding money to spend on personal or family needs. Business motive
refers to where money is held to meet business recurring needs such as paying wages.

b) The precautionary motive

This is where people tend to hold money to meet expenses that may occur unexpectedly. Such
expenses may relate to sickness, accidents etc.

The amount of money held for precautionary purposes may depend on factors such as:

 Level of income: people with high levels of income tend to keep more money to cater
against emergencies than people with low income levels
  Family status: high class individuals with high incomes tend to hold more money as a
precautionary measure against emergencies as compared to low class individuals
 Age: older people are prone to health complications as compared to younger, they
therefore need to keep more money to guard against emergencies
 Number of dependants: with more dependants, emergencies will be more hence more
money has to be held to guard against these emergencies
 Individual temperaments: this has to do with how a person perceives life. An optimistic
person will assume that nothing will go wrong in the future, such person will therefore
keep little money to guard against emergencies as compared to a pessimistic person
who assumes that many things will happen in the future
 Interval between incomes: when the interval between incomes is long, more money
will be held to cater against as compared to when the interval between incomes is short
c) The speculative motive

This refers to holding money to spend in the future when economic conditions become
favorable. For example an individual will keep his money inorder to spend it in the future when
prices are low

Amount of money held for speculative motive will depend on the following factors:

 Levels of income: the higher the income level, the higher the amount of money held
 Individual temperaments: an optimistic person who doesn’t care the future happens
will keep less money for speculative purposes as compared to a pessimistic person who
is very conscious about the future.

Supply of money

Supply of money refers to the stock of monetary items in circulation at a given time. These
monetary items may consist of

 Total currency in form of notes and account

 Total monetary deposits in commercial banks

Factors influencing the supply of money in the economy

a) Central bank’s monetary policy

b) Ability of commercial banks to lend money to the public
c) Ability of central bank to control the lending ability of commercial banks
d) The rate of interest in the economy i.e. higher interest rates limits lending by
commercial banks resulting in lower supply of money and vice versa
 e) The national budget i.e. the higher the national budget, the higher the supply of money
and vice versa

BANKING

Banking refers to all the activities carried out by banks and other financial institutions involving
money.

Development of banking

Banking developed from the services offered by goldsmiths and silversmiths. These services
included:

 Accepting deposits of precious metals from the public

 Providing safe custody of the precious metals received
 Providing loans to traders from the deposits of precious metals held and charging
interest on those loans
 Issued paper notes to the depositors which facilitated change of ownership of the
precious metals deposited without having to withdraw the deposits

Many goldsmiths and silversmiths emerged to provide these services prompting governments
to start controlling their activities. This led to the rise of banks and the need to control these
banks led to the emergence of the central bank.

Banking system in Kenya consists of;

 The central bank

 Commercial banks
 Non-banking financial institutions
a) Commercial banks

These are banks which are formed with the main aim of making profit through financial
intermediation. Their profits are made through:

 Interests earned on loans and overdrafts extended to customers

 Investments in the economy
 Income from daily operations e.g. ledger fees charged on customers’ deposits

Examples of commercial banks in Kenya may include:

 Kenya commercial bank

 Family bank
 National bank of Kenya
  Standard chartered bank
 Co-operative bank of Kenya etc.

Services offered by commercial banks

a) Accepting deposits

Deposits constitute money kept in commercial banks by customers. By accepting deposits help
people save their money. These deposits are accepted in three main accounts depending on the
customers' desire namely

 Current account
 Savings account
 Time(fixed) deposit accounts
b) Lending money

Lending money refers to giving out money in form of loans. Commercial bank gives loans to
individuals, businesses and government agencies. Such loans attract interest at given rates.
These loans encourage investments in the economy leading to economic growth.

c) Safekeeping of valuable items

Commercial banks do accept some valuable items from their customers for safekeeping. Such
valuable items may include title deeds, jewelry, wills etc. a fee is charged for safekeeping of
these items.

d) Facilitating transfer of money

Commercial banks provide methods through which money can be transferred from one person
to another. This is made effective using methods such as; cheques, standing orders, credit
transfers etc.

e) Provision of foreign exchange

Commercial bank facilitates the exchange of different currencies. This is done to facilitate
foreign trade. To offer foreign exchange services, commercial banks charge a fee.

f) Offering advisory services

Through their customer care services, commercial banks advise their customers on the
available investment opportunities and on the best ways to manage their funds.

g) Provision of trustee services

Commercial banks can undertake to manage a deceased customer’s property on behalf of the
inheritors if requested by the customer. This is mostly done if by the time of death of the
customer, inheritors were minors. The property is passed over to the inheritors when they
attain maturity. To do this, the bank charges a fee.

h) Acting as guarantor or referee

Commercial banks may act guarantors to their customers who want to acquire goods on credit
or borrow money from other financial institutions

i) Linking savers and borrowers

By accepting deposits and lending money in for of loans, commercial banks provide a forum
through which savers and borrowers can interact

Money transfer services

a) Standing order

This is an instruction to the bank from the account holder to be paying a given amount of
money to a named person at given intervals for as specific period of time.

b) Credit transfer

This is method where one cheque is used to pay a given number of people whose account
numbers and names are written on the cheques

c) Telegraphic transfer

This is a method of transferring money from one account holder to another. The sender fills an
application form containing the details of the payee

d) Electronic funds transfer

This is a method of transferring money from one account holder to another via computers
within the same bank or between different banks

e) Cheque

This is a written order by the account holder (drawer) to his bank to pay on demand a specified
amount of money to the person named on its face (payee) or to the bearer.

f) Credit cards
These are cards which allows the customer to obtain goods and services from specified sellers
without paying for them in cash. The value of the goods is deducted directly from the buyer’s
bank account and the money remitted to the seller

g) Travelers cheques

These are cheques which are issued to travelers in and out of the country to settle their debts
in the country’s they are visiting

Commercial bank accounts

Commercial banks accept deposits from their customers into three accounts;

 Current accounts
 Savings accounts
 Fixed(time) deposit accounts
a) Current accounts

This is an account where money can be deposited and be withdrawn at any time provided there
is sufficient funds in the account

This account is suitable for business people who need money regularly

Its features

 Money is withdrawn at any time

 No minimum balance is required to be maintained in the account
 Account holders are allowed to use cheques to facilitate payments
 Money deposited in the account do not earn interest
 Customers can withdraw in excess of what is in their account. This excess withdrawal is
known as an overdraft
 Deposits can be made at any time
 The bank charges ledger fees for maintaining the account
 The account holder is given periodical bank statements to show a summary of the
transactions between him/her and the bank for a given period of time

Advantages of a current account

 They allow overdrafts

 Cheques can be used to effect withdrawals and make payments
 No minimum balance is to be maintained
 Regular bank statements are issued to the account holder
  Money can be deposited at any time
 Money can be withdrawn at any time

Disadvantages of current accounts

 No interest earned on deposits

 Ledger fees is charged to operate the account
 Withdrawals at any time discourages savings
b) Savings account

This is an account where money deposited is only withdrawn after a given period of time.
Suitable for those who are interested in saving.

Its features

 Money deposited beyond a certain minimum earns interest

 Cheques are not used by the account holder to facilitate payment
 Overdrafts are not allowed
 A minimum balance has to be maintained in the account
 A notice must be served when withdrawing large amount of money exceeding a given
limit
 Money is only withdrawn by the account holder himself
 Money can be deposited in the account at any time
 An initial deposit is required when opening the account

Advantages of a savings account

 Earns interest
 Low initial deposit
 Deposits can be made at any time
 Restrictions on withdrawals encourages savings
 Deposits can be made at anytime

Disadvantages of savings accounts

 A minimum balance is required to be maintained at all time

 A fee is charged when withdrawing
 Ledger fee is charged to operate the account
 Overdrafts are not allowed
c) Fixed(time) deposit account
This is an account where money deposited cannot be withdrawn until after the expiry of an
agreed upon period. The period can be 3 months, 6 months, 1 year or 5 years. During this
period no further deposits can be made.

This account suitable for people who have money that is not intended for immediate use.

Its features

 Earns interest at an agreed rate depending on the amount of money deposited and the
duration
 There is a minimum amount of money that can be deposited in this account
 A deposit certificate is issued to the account holder to act as evidence of the contract
 If money is withdrawn before the expiry of the agreed period, no interest is earned
 At the expiry of the agreed upon period, all the money can be withdrawn together with
the interest earned
 Involves large amounts of deposits
 Money is deposited in the account once
 The rate of interest is usually higher than in savings accounts
 There is a minimum amount of money that can be deposited in the account

Advantages of fixed deposit accounts

 Allow the account holder time to plan on how to spend the money deposited
 Deposited money can be used as a collateral security for a loan
 High interest is earned
 No ledger fees
 Encourages savings

Disadvantages of fixed deposit account

 A notice is given when terminating the account

 No interest if money is withdrawn before the expiry of the contract period
 Money deposited cannot be accessed before maturity of the period
 No regular deposits
 Minimum balance is high

Differences between fixed deposit accounts and savings accounts

Fixed deposit accounts Savings accounts

Money is not withdrawn until the contract is Money is withdrawn after an agreed interval
over
Can be used as a security for a bank loan Can be used as a security for a bank overdraft
The account remains in force for a specific The account is in force as long as the minimum
period of time balance is maintained
A large amount of money is required to open A small amount of money is required to open
the account the account
A separate account is required for each All deposits can be made in the same account
deposit
A certificate of deposit is issued once money is A passbook or a bank card is issued when
deposited in the account deposits are made into the account
Interest earned is high Interest earned is low

Differences between savings accounts and current accounts

Savings accounts Current accounts

Withdrawals are made after a specific period
of time
A minimum balance must always be
maintained in the account
Cheques cannot be used to make payment
Overdrafts are not allowed
Interest is earned on the money deposited
Large withdrawals require a notice to be given
to the bank
Money remittance services are not permitted
Withdrawals are made at any time
No minimum balance is required to be
maintained in the account
Cheques are used to make payment
Overdrafts are allowed
No interest is earned on the money deposited
Any amount of money can be withdrawn from
the bank without a notice to the bank
Money remittance services are permitted

Reasons why majority of Kenyans do not operate bank accounts

 Most Kenyans earn low incomes which is entirely consumed hence no savings to keep in
bank accounts
 Requirements to open bank accounts are not favourable to most Kenyans
 Instability in the banking sector discourages most Kenyans from operating bank
accounts
 Ignorance of the existence of banking facilities by most Kenyans
 Banking facilities are located far away from some people

Ways in which commercial banks advance money to their customers

 Bank overdraft facilities

 Discounting bills of exchange and promissory notes
 Giving out personal loans

Disadvantages of a bank overdraft

  It may be expense as interest charged is high
 Frequent use of overdraft by the business may be seen as a sign of mismanagement by
financiers
 Banks may recall the overdraft at any time
 Overdrafts are not easily available unless one is well known or has a good reputation
 Overdrafts are only given to current account holders
 Overdrafts offer a limited amount of financing hence not suitable for long term financing
 Overdrafts require short repayment period which may affect the cash flow of the
business

Reasons why commercial bank loans are not popular in Kenya

 High rate of interest is charged on the loans

 Individuals and firms may have cheaper sources of loans
 Not so many people have accounts with commercial banks
 Acquiring commercial bank loans involves a lengthy procedure
 Many people fear the consequences of failing to repay the loans
 Many people do not have recognized property to attach as collateral security
b) The central bank

This is a financial institution which is established by the government of the country to manage
and control the supply of and demand for money

Functions of the central bank

a) Issue of currency

The responsibility of issuing new currency lies with the central bank. The central bank will
ensure adequate amount of money is in circulation. This is because excess money leads to
inflation while too little money may suppress economic activities

b) Acts as a banker to commercial banks

The central bank offers banking services to the commercial banks. These banking services
include:

 Maintains current accounts for commercial banks

 Receiving money deposits from commercial banks and providing safe custody of such
deposits
 Facilitates the settlement of inter-bank debts
 Lends money to commercial banks
  Advices commercial banks on financial matters
c) Acts as a banker to the government

The central bank provides banking services to the government. These banking services include:

 Maintains current accounts for all government ministries and departments

 Receiving money deposits from the government and providing safe custody of such
deposits
 Making payments on cheques drawn by the government
 Advising the government on financial matters
 Providing safe custody of funds received from abroad on behalf of the government
d) Controlling commercial banks

The central bank regulates the operations of commercial banks by giving them instructions on
lending procedures and proper banking practices. This is done to prevent these commercial
from exploiting their clients. Some of the methods used by central bank to regulate commercial
banks include the following:

 Licensing commercial banks

 Inspecting commercial banks
 Approving the establishment of branches of commercial banks
 Ensuring the protection of depositors funds
 Punishing and closing down errant commercial banks
 Interpreting and implementing government monetary policies to all commercial banks
e) Links the country to external financial institutions

The central bank links the country with external financial institutions such as World Bank and
the IMF. This facilitates healthy financial relationships enabling the country access financial
assistance from such institutions

f) Maintaining stability in exchange rates

The central bank monitors the rates of exchange between the local currency and other
currencies. It therefore comes up with methods of ensuring that stability in exchange rates is
maintained at all time. This is done through the following methods:

 Devaluation of the local currency

 Ensuring that no commercial bank is allowed to effect payments abroad without seeking
permission from the central bank
 Ensuring that no commercial bank is allowed to buy or sell foreign currency without
seeking permission from the central bank
  Requiring commercial banks to submit periodic reports to the central bank showing
their foreign exchange deals
g) Lender of last resort

The central bank can give loans to commercial banks. Commercial banks can therefore obtain
loans from the central bank to meet their daily financial obligations when need arises

h) Facilitates clearing of cheques

Through the clearing house, the central bank facilitates the clearing of cheques between
different commercial banks

i) Administering public debt

Public debt refers to all outstanding government borrowings both internal and external. The
central bank is responsible for ensuring that such a debt is paid. The central bank therefore
does the following:

 Sales government securities such as treasury bills and bonds to the public
 Discounts government securities
 Redeeming government securities on maturity
 Maintains a register of all government securities
 Paying accrued interest on government securities
j) Controlling monetary system

The central bank controls the supply of money in the economy. It does by using certain
methods known as the instruments of monetary policy which will be discussed later.

The monetary policy

Monetary policy refers to the deliberate move by the government through the central bank to
manipulate the supply, availability and cost of money in order to achieve the desired economic
levels

Reasons for monetary policies

 To facilitate rapid and steady economic growth

 Create employment
 Stabilize prices of goods
 Ensure balanced economic development
 Ensure equilibrium in the balance of payments

Tools of monetary policy

These are methods the central bank uses to control the supply of money in the economy. These
tools are discussed below

a) Bank rate policy

The central bank as lender of last resort gives loans to commercial banks at an interest rate.
This interest rate determines the lending rates of commercial banks to individual borrowers. To
reduce the supply of money in the economy therefore, the central bank will increase its lending
rate forcing commercial banks to increase rate of interest on their loans. This makes loans
expensive therefore discouraging borrowers. On the other hand to increase the supply of
money in the economy, the central bank will lower its lending rate making loans cheaper hence
encouraging borrowing

Factors limiting the effectiveness of bank rate policy

 Availability of excess reserves in commercial banks enabling them to lend money to the
public without having to approach the central bank for more money.
 Few monetary transactions especially in under-developed countries
 Existence of other lending institutions such as SACCOs from where loans can be
accessed by the public
 Reduction in the number of potential borrowers to the extent that changes in bank rates
have no effect on borrowing
 Savings and investments are done purely for safety reasons but not to earn interest
b) Open market operations(OMO)

The central bank can regulate the supply of money in the economy by selling or buying
government securities in the open market. Government securities include treasury bills and
government bonds.

To reduce the supply of money in the economy, the central bank sells these government
securities to the public, this will help in withdrawing money from the economy as people pay
for these securities through commercial banks

On the hand the central bank can increase the supply of money by buying bank the government
securities earlier sold. This will have an effect of releasing more money to the economy thereby
increasing the supply of money

c) Cash/liquidity ratio requirement

The central bank requires commercial banks to hold a certain proportion of their total deposits
in form of cash in order to assist in meeting their day to day operations. This proportion is
known as the cash ratio.
Cash ratio = cash held / total deposit

At other times, the central bank may require commercial banks to hold part of their total
deposits in the form of liquid assets. This proportion is known as the liquidity ratio

To reduce the money supply in the economy, the government will reduce the amount of money
always available in the cash. This will reduce the amount of money available for lending. On the
other hand reducing the amount of money always available in commercial banks reduces their
ability to lend.

d) Compulsory deposit requirements

The central bank may require commercial banks to deposit a specific amount of money in the
accounts they hold with it. These deposits will affect the amount of money available for lending
by commercial banks. To reduce money supply therefore, the central bank will increase the
amount of the compulsory deposits. On the other hand, to increase the supply of money, the
central bank will reduce the amount of compulsory deposits.

e) Selective credit control

The central bank may give instructions to commercial banks to only lend money to specific
sectors of the economy. This will reduce the supply of money. On the other hand, to increase
the supply of money, the government will reduce all forms of restrictions

f) Directives and requests

The central bank may give directives to the commercial banks on the rate of interest to charge
on their loans. To increase the supply of money, directives to lower interest rates will be issued.
On the other directives to increase interest rates will be issued if the objective is to reduce the
supply of money.

The central bank may also request commercial banks to adjust their interest rates as required.
This is known as moral persuasion

Limitations of monetary policies

a) Bank rates may not be effective where central banks lacks the power to enforce its rules
b) Treasury bills lack a wider market hence hindering the effectiveness of open market
operations
c) Central bank may have limited control over commercial banks especially in developing
countries
d) Limited use of cheques and other banking services renders monetary policies ineffective
c) Non-banking financial institutions
These are institutions which address financial needs of specific sectors of the economy which
commercial banks cannot address. These institutions include;

a) Development financial institutions

These are institutions which offer financial services to the manufacturing sector. Examples may
include:

 Kenya industrial estate

 Industrial development bank etc.
b) Housing finance companies

These are institutions whose major responsibilities to finance housing activities. They do this by
either putting up houses which they sell to interested people or by giving mortgages to people
to buy houses. Examples may include:

 Housing finance company of Kenya

 East African building society
c) Savings and credit co-operative societies(SACCOs)

These are financial institutions which are formed to enable members save and access loans
more conveniently. They are formed by people engaged in similar activities or are under a
similar employer. Examples include:

 Mwalimu Sacco
 Kakuma lima Sacco
 Stima Sacco etc.
d) Insurance companies

These are financial institutions which guard against risks. They also encourage savings.
Examples may include:

 Madison insurance company

 Blue shield insurance company
 British American insurance company etc.
e) Micro finance companies

These are institutions which offer financial services to small scale and medium sized
enterprises. Examples may include:

 Faulu Kenya
 Kenya women finance trust etc.
 f) Agricultural finance houses

These are institutions which offer financial services specifically to the agricultural sector e.g. the
agricultural finance corporation.

Functions of Non-banking financial institutions

 Giving loans
 They offer training services
 Advisory services that equip people with knowledge on how to set up and run
businesses
 They may extend guarantee/trustee services to members
 They offer savings services to their clients
 They generate revenue to the government through tax and dividends
 They supplement the government’s effort of developing the economy
 They create employment opportunities

Advantages of borrowing money from non-banking financial institutions

a) They give long-term loans

b) They provide finances for specific projects
c) They give loans at relatively lower interest rates compared to commercial banks
d) They accept lower collateral value
e) They give longer grace period for loan repayment

Differences between commercial banks and Non-banking financial institutions

Commercial banks Non-banking financial institutions

They provide current accounts
They provide short term and medium term
loans
They are under the direct control of the
central bank
They offer finances to all sectors of the
economy
They provide foreign exchange services
They participate in the central bank clearing
house
They safe keep valuable items
They finance working capital
Offers bank overdrafts for current account
holders
They don’t provide current accounts
They only provide long term loans
They are not directly controlled by the central
bank
They only offer finances to specific sectors of
the economy
They do not provide foreign exchange services
They do not participate in the central bank
clearing house
They do not safe keep valuable items
They finance capital for development
They do not offer bank overdraft facilities
Similarities between commercial banks and non-banking financial institutions

a) Both accept deposits from the public

b) Both lend money to the public
c) Both are registered under the banking act except building societies
d) Both pay interest on money deposited with them
e) They both provide investment advice to their clients
f) They both charge interest on loans advanced to their clients

NOTE: Due to the current changes in the banking industry, some non-banking financial
institutions are now carrying out banking activities

Trends in banking

a) Introduction of automated teller machines(A.T.Ms)

Advantages of ATMs

 They are conveniently located

 They offer 24hr services
 Transactions are secured through pin
 They provide additional information about the account
 They save time
 ATM cards can be used as credit cards to buy goods
 They are cheaper
 ATM cards are highly portable
 Withdrawals can be done on behalf of somebody

Disadvantages of ATMs

 They may not be used by the illiterate

 They contribute to unemployment
 They encourage cases of theft
 ATM machines are not always available

b) Introduction of computer usage which have facilitated networking of branches

c) Restructuring of accounts
d) Soft conditions on loan access
 e) Improved customer care services
f) Introduction of mobile banking through M-pesa and airtel money which enables users
 Send money
 Withdraw money
 Buy airtime
 Access account balance
 Buy goods and services from registered sellers
 Withdraw money from A.T.Ms
g) Introduction of pesa point money services where money can be withdrawn at any time
h) Introduction of mobile banks.

TOPIC 4: PUBLIC FINANCE

CONTENTS

 Introduction
 Sources of public finance
 Government borrowing
 Government expenditure
 Taxation
 Budget

INTRODUCTION

Public finance refers to all activities carried out by the government in relation with raising of
finances and the spending of the finances raised

SOURCES OF PUBLIC FINANCE

 Fines imposed by courts on offenders

 Rent and rates paid for using government property
 License fees paid by those who want to operate businesses
 Dividends and profits earned from government direct investments
 Interests earned on loans advanced by the government to firms
 Proceeds from sale of government property
 Taxes
 Government borrowing

NOTE: The main sources of public finance are taxes and government borrowings

GOVERNMENT BORROWING
The government may borrow from internal or external sources. Internally the government may
borrow from commercial bank while externally it can borrow for the World Bank

The government can only borrow when finances raised from the sources listed above are
inadequate.

Outstanding government borrowing is referred to as public debt or national debt

Types of government borrowing

a) Internal borrowing

These are the borrowings by the government from firms and individuals within the country.
This is done through O.M.O.

b) External borrowings

These are the borrowings by the government from outside the country

The government may borrow externally from another country (bilateral) or from international
financial institutions (multilateral)

The sum of internal and external borrowing is referred to as national debt. National debt can
further be classified into two:

Reproductive debt: refers to money borrowed by the government that is used to finance
activities that generate additional income e.g. debts used to finance irrigation projects

Dead weight debt: refers to money borrowed by the government that is not used to finance
activities which generate no income e.g. debts used to finance salaries for civil servants

Factors influencing government borrowing

 Cost of borrowing
 Borrowing conditions
 Whether borrowing will deprive funds hence leaving little for private sectors to borrow
from.

GOVERNMENT (PUBLIC) EXPENDITURE

Refers to spending by the government

Categories of government expenditure

a) Recurrent expenditure
Refers to spending by the government that takes place on a regular basis e.g. payment of
salaries to civil servants, providing free drugs to public hospitals etc.

b) Development expenditure

Refers to spending by the government aimed at financing development projects e.g.

construction of roads, construction of schools etc.

c) Transfer payments

Refers to the amount of money paid by the government to people who do not contribute to
national income generation e.g. money paid as bursaries to needy students.

d) Capital expenditure

Refers to the amount of money spent by the government to buy fixed assets such as vehicles

Principles of government expenditure

Principles refer to rules and conditions governing spending by the government. These principles
include:

a) Sanctions

According to this principle, any government expenditure must be approved by relevant

authorities before it is executed. The approving authority in most cases is parliament.

b) Maximum social benefit

According to this principle, Government expenditure, must aim at benefitting majority of the
country’s citizens

c) Flexibility

According to this principle, public expenditure should be flexible enough to allow adjustments
in order to meet prevailing economic situations e.g. diverting public expenditure to avert
hunger during times of drought

d) Economy

According to this principle, public expenditure should avoid wastage that may result in
unnecessary losses.

e) Proper financial management

According to this principle, public funds should be well managed. This is done by keeping
proper accounting records which are audited regularly.

Functions of public finance

Functions of public finance refer to the reasons explaining why the government engages itself in
activities concerned with raising and spending of finances. These reasons include:

a) Provision of essential services

The government raises money in order to provide essential services such as health care to its
citizens at a cheaper cost

b) Raising revenue

Revenue refers to all moneys collected by the government. The government engages in public
finance in order to generate revenue which is to be used in financing its activities

c) Controlling the consumption of certain products

The government uses public finance to control the consumption of harmful products such as
alcohol and cigarettes by increasing taxes levied on them

d) Encouraging the consumption of certain products

Through public finance, the government may encourage the consumption of certain products
such as fertilizers. This is done through introducing subsidies or lowering taxes on such products

e) Promoting balanced regional development

Through public finance, the government can promote equitable regional development by
initiating development projects in areas that are lagging behind in development. This can also
be done by giving subsidies and tax holidays to those willing to set up businesses in
underdeveloped areas

f) Redistribution of wealth

The government can redistribute wealth by taxing the rich more and using the money obtained
to provide essential services to the poor.

g) Promotion of economic stability

Economic stability can achieve by initiating development projects which create employment
opportunities using the money raised through public finance.
 h) Creation of a conducive business environment

The government can use the money raised through participation in public finance to improve
infrastructure which help in encouraging investments

TAXATION

Tax: a tax is a compulsory payment by individuals and organizations to the government. These
payments are not made in exchange for anything

Taxation: taxation is the process through which the government raises its revenue by collecting
taxes

Reasons for taxation

a) Raising revenue

Taxes help generate revenue for the government which is used to provide essential services

b) Discourage the consumption of harmful products

Increasing taxes on harmful products such as alcohol and cigarettes will discourage their
consumption

c) Discouraging the importation of certain products

Importation of certain products can be discouraged by increasing taxes charged on them. This is
done in order to protect home industries from unfair competition from foreign industries which
may lead to their collapse.

d) Reducing inequalities in income distribution.

This is done by taxing the rich more and using the money raised to provide essential services to
the poor

e) Controlling inflation

Taxes reduce the supply of money in the economy therefore lowering general demand leading
to decrease in prices

f) Influencing the location of industries

The government may influence the location of business by lowering taxes on profits made by
firms located in certain regions
 g) Correcting balance of payments

High taxes on imports may discourage importation hence contributing to a favourable balance
of payments

NOTE: The major reason for taxation is to raise revenue

Factors determining the amount of tax to be collected

a) Distribution of incomes

The government will collect more tax when incomes are evenly distributed unlike when
incomes are unevenly distributed. This is because almost everybody is brought into the tax
bracket

b) Social and political factors

When a country is politically stable, the amount of tax collected is more than when there is
political instability

c) Honesty and efficiency of tax authorities

Transparency among the officials charged with tax collection will enable the government raise
more revenue through taxation since they will guard against corruption

d) Level of incomes

When citizens earn more, they pay more tax than when they earn less

e) Economic structure of the country

Refers to the relative sizes of commercial and subsistence sectors. When the commercial sector
is larger than the subsistence sector, more tax is collected from the incomes created.

Principles of taxation

Refers to the characteristics that a good tax system must have. They are also known as the
cannons of taxation. They include the following:

a) Equitable

A good tax system should ensure fairness in payment in that the tax burden is distributed
equally

b) Certainty
Tax to be paid should be clear in terms of amount, time and manner in which it should be paid

c) Convenience

Tax should be charged at a time and manner convenient to the tax payer e.g. at the end of the
month through a check-off system

d) Economical

The cost of collecting and administering tax should be lower than the revenue collected

e) Flexibility

A good tax system should be able to adapt to changes in national income in the sense that
when national income rises, more tax is collected and vice versa

f) Elastic

A good tax system should allow the adjustment of tax rates at any time in order to enable the
government increase revenue when need arises

g) Ability

The amount of money to be charged as tax should be reasonable to enable the taxpayer pay
without straining

h) Diversification

A variety of taxes should be levied in order to bring as many citizens as possible within the tax
bracket so as to ensure maximum revenue collection

i) Simplicity

The mechanism of calculating tax should be simple in order to be understood by each tax payer

Impact and incidence of a tax

Impact: refers to the tax burden on the initial person the tax is imposed

Incidence: the final resting place of the tax

Classification of taxes

1) According to structure
Taxes are classified according to the relationship between the amount paid as tax and the
income of the tax payers. These include:

 Progressive taxes
 Proportional taxes
 Regressive taxes

a) Progressive taxes

This is a tax system where the amount of tax paid increases proportionately with increase in
income e.g. income tax

Some of the disadvantages of a progressive tax are:

 Discourages vertical mobility of labour

 Reduces output
 Discourages people from working more
 Discourages investors
b) Proportional taxes

This is a tax system where a fixed percentage is used to calculate tax to be paid e.g. value added
tax

c) Regressive taxes

In this tax system, low income earners pay more tax than high income earners i.e. the tax rate
decreases with an increase in income

2) Classification according to impact on the tax payer

Based on the impact, the tax has on the tax payer; a tax may be classified either as direct or
indirect.

DIRECT TAXES

These are taxes where the incidence and the impact of the tax is on the same person

Types of direct taxes

 Personal income tax e.g. P.A.Y.E

 Corporation tax: tax on companies’ profits
 Stamp duty: tax paid on conveyance of land to another person
 Estate(death)duty: tax charged on property transferred after death the owner
  Wealth tax: tax charged on personal wealth that goes beyond a certain limit
 Capital gains tax: tax charged when a fixed asset is sold at a higher price than the book
value
 Capital transfer tax: tax imposed on the value of property transfered from one person
to another
 Specific duty: this is a tax that is based on the quantity of goods irrespective of their
value
 Ad valorem: this is a tax that is based on the value of goods

Merits of direct tax

a) Economical in collection

Most direct taxes are collected at source therefore reducing the cost of collection greatly

b) Tax revenue is certain

The government is assured of the revenue expected from direct taxes. This is because based on
incomes which in most cases must be earned

c) Equitable

Direct taxes ensure that there is fairness in payment of tax such that high income earners pay
more tax than low income earners

d) Does not affect the price of goods and services

Direct taxes do not lead to inflation. This is because they are levied on consumer incomes.

e) Ensures equitable distribution of wealth

Direct taxes ensure equity in income distribution. This is because high income earners are taxed
more than low income earners and the incomes obtained are used to provide essential services
for the poor

f) Makes taxpayers conscious

Tax payers are aware that they pay tax; therefore they become keen on how their money is
spent. This makes the government spend this money efficiently.

g) Simple to understand

Direct tax is simple to understand by both the contributor and the collector

h) Highly desirable
The tax is desirable since it affects only a few people in the economy

i) Elastic and flexible

The rates of direct taxes can be adjusted at any time in order to raise the required revenue.

Benefits of direct taxes to the government

a) Enhances distribution of wealth

b) The society is aware of direct taxes hence they monitor the usage of revenue collected
from these taxes
c) It is simple to administer
d) It has a wide tax base hence more revenue is collected
e) It is simple to understand
f) It is economical to collect
g) It is elastic i.e. the tax rates can be lowered or increased according to the needs
h) It does not affect the prices of goods and services

Demerits of direct taxes

a) Easy to evade

Contributors can easily evade paying tax by provide false information about their incomes

b) Reduces savings

Direct taxes reduce the ability of tax payers to save since it reduces their incomes. This
negatively affects investments.

c) Discourages people from working

High rate of direct tax may discourage people from working since any extra income they earn is
taxed

d) Discourages investments

Heavy taxes on profits discourages investments since taxes will reduce this profits

e) Inconvenience

Direct taxes may highly inconvenience the tax payer as he will be required to adjust his personal
budget in order to pay this tax.

f) Not imposed on all citizens

Low incomes earners whose level of income does not fall within the tax bracket do not pay
direct tax. This reduces the amount of revenue collected by the government.

INDIRECT TAXES

These are those taxes where the tax burden can be shifted to another person. These are in
most cases imposed on goods and services consumed. These taxes include:

 Sales tax: sales imposed on sales made by the seller

 Value added tax: tax imposed on the value the business adds to its final product
 Export duty: tax levied on exports. The aim is to raise revenue and discourage
exportation of specific products
 Import duty: tax charged on imports. The aim is to raise revenue, reduce dumping and
discourage importation of specific products.
 Excise duty: tax imposed on goods manufactured and sold locally. The aim is to raise
revenue and discourage the consumption of harmful products.

Merits of indirect taxes

a) Can be used selectively

Indirect taxes can be used selectively to achieve certain objectives e.g. the government may
raise tax on alcohol to discourage their consumption

b) Tax payment is voluntary

Taxpayer may choose whether to pay or not to pay tax by avoiding buying the taxed product

c) Difficult to evade

It is not easy to evade paying indirect taxes because they are attached to the price of the
product

d) Encourages people to work harder

Indirect taxes have the effect of increasing the price of goods. As a result, people are forced to
work harder in order to earn more incomes to enable them afford buying products whose
prices has risen.

e) Convenience

Indirect taxes are convenient since they are paid in small amounts. The tax is also hidden in the
price to the extent that the buyer may not be aware of the tax.
 f) Elastic

It is easy for the government to adjust the tax rates inorder to suit different economic
conditions.

g) Raises more revenue

Compared to direct taxes, indirect taxes raise more revenue to the government since it is paid
by many people.

Demerits of indirect taxes

a) Leads to increase in prices

Since indirect taxes are imposed on products, they are likely to lead to price increase

b) Less equitable

The burden of indirect taxes falls uniformly on all consumers irrespective of their levels of
income. This is because they all buy taxed products at the same price. It is therefore more of a
burden to the poor than to the rich.

c) Easy to avoid

Indirect taxes can be avoided by those people who don’t buy the taxed product. This is likely to
reduce government revenue

d) Leads to uncertainty in revenue collection

The amount of revenue collected from indirect taxes varies with time as a result the
government cannot forecast the expected amount of revenue

e) Lack of contributor’s awareness

Since indirect taxes are hidden in the price of the product, many contributors are not aware
that they pay tax. As a result they don’t monitor how revenue collected is being spent.

f) Interferes with the production of specific products

Indirect taxes may affect negatively the quantity produced of taxed products as consumers shift
their demand to non-taxed product.

g) Expensive to collect
Collecting indirect taxes is quite expensive since inspectors have to be employed to ensure that
manufactures submit the right amount of tax collected to the tax authorities.

BUDGET

A budget is a statement of estimates or proposals of the way the government plans to raise
finances and how such finances are to be spent in a given year known as the financial/fiscal
year.

Types of Budgets

a) Balanced budget

This is a budget where budgeted expenditure equals budgeted revenue

b) Deficit budget

Ways of financing a deficit budget

a) Borrowing from central bank through overdrafts, short term loans etc.
b) Borrowing from international financial institutions such as the world bank and IMF
c) Borrowing from capital markets e.g. AFC.
d) Borrowing from domestic money markets such as commercial banks, the public through
the sale of treasury bills and bonds
e) Borrowing from other countries
f) Getting grants or donations from mother countries, agencies and individuals
g) Printing currencies not backed by production of goods and services
h) Imposing additional or new taxes on selected goods
i) Sale or lease of government assets
j) Putting in place cost-cutting measures to reduce government expenditure

This is a budget where the budgeted revenue is less than budgeted expenditure

c) Surplus budget

This is a budget where budgeted revenue is more than budgeted expenditure

Importance (uses) of a budget

a) It identifies the sources of government revenue

b) Aids in allocating the available revenue properly
 c) It shows the impact of various monetary and fiscal policies in the economy e.g. the
impact of price or wage levels
d) Aids in establishing policies which are meant for the redistribution of national wealth
equitably
e) Helps in the formulation of policies meant to spur economic growth
f) It helps in controlling unplanned expenditure by the government
g) It helps in the formulation of measures to curb inflation

TOPIC 5: INFLATION

CONTENTS

 Introduction
 Consumer price index
 Levels of inflation
 Types and causes of inflation
 Effects of inflation in an economy
 Controlling inflation

INTRODUCTION

Inflation refers to the persistent and significant general rise in prices of goods and services in a
given country. Its opposite is deflation.

CONSUMER PRICE INDEX

An index is a number which compares the level of a certain item or process at a given time with
the level of the same item or process at a previous time. Consumer price index therefore
measures prices of goods between two prices and is used to calculate inflation rate.

Example: if the price of a loaf of bread was sh 50 in 2010 and it increased to sh 60 in 2011, then
the consumer price index is calculated as follows:

Change in price = 60-50 = sh 10,

Taking 2010 as the base year, C.P.I = (change in price ÷ price in 2010) × 100

i.e. (10 ÷ 50) × 100 = 20%, therefore, C.P.I = 100% + 20% = 120%

Factors to consider when calculating C.P.I

 Selection of commodities consumed by almost all consumers

 Selection of the base year i.e. the year when prices were fairly stable
  Prices of commodities

LEVELS OF INFLATION

a) Moderate/creeping/mild inflation

In this level of inflation, general prices increases slowly i.e. at a less than 10% rate

b) Galloping inflation/rapid inflation

In this level of inflation, general prices rise rapidly i.e. in terms of tens or hundreds percent

c) Hyper-inflation

In this level of inflation, general prices rise at a very extremely high rate i.e. in terms of
thousands or millions percent. Under hyper-inflation, people lose confidence in their monetary
system as a lot of money is required to buy very few commodities.

TYPES AND CAUSES OF INFLATION

a) Demand-pull inflation

This is a type of inflation that is caused by increase in demand for goods and services which
leads to increase in prices. It is as a result of a lot of money chasing few goods.

Its causes

a) Increase in government expenditure

When the government spends more money in financing its activities, it increases the supply of
money in the economy leading to increase in general demand for goods and services which
finally results in inflation.

b) Credit creation by commercial banks

Credit creation is the process through which banks lend out money to individuals and business.
This process increases the supply of money in the economy leading to increase in general
demand which finally results in inflation.

c) Increase in incomes

Increase in people’s incomes increases their purchasing power resulting in increase in prices

d) General shortages of goods and services

In cases of a shortage, demand tends to be higher than supply. This high demand tends to pull
prices of goods upwards

e) Increase in consumer expenditure

When consumers spend more of their money to buy goods and services, sellers may be
influenced to increase the prices of goods resulting in inflation

b) Cost-push inflation

This is a type of inflation that is caused by increase in cost of production of goods and services
which make suppliers increase their selling prices.

Its causes

a) Rise in wages and salaries

When workers push for higher salaries, producers will transfer such costs to consumers by
increasing selling prices of their products resulting in inflation.

b) Increase in taxes

When the government imposes taxes on profits and firm inputs, producers will respond by
increasing prices

c) Desire for higher profits

When firms want to make more profits, they will increase market prices for their products
resulting in inflation

d) Reduction in subsidies

When the government withdraws or reduces subsidies given to producers, the cost of
production increases making producers increase their selling prices resulting in inflation.

e) Increase in the cost of inputs other than labour

When prices of other inputs to the production process other than labour increases, producers
will recover such increased costs from consumers by increasing market prices

c) Imported inflation

This is a type of inflation that is influenced by imports. When highly demanded expensive goods
are imported to the country, they may make local manufacturers increase the prices of their
goods so as to appear competitive.
 d) Structural inflation

This is a type of inflation that is caused by the inability of the economic variables respond to
increasing demand in the country

Its causes

a) Shortage of raw materials due to exhaustion or restricted supply

b) Poor entrepreneurial culture i.e. failure by producers to expand production or output
c) Poor infrastructure
d) Lack of skilled manpower

EFFECTS OF INFLATION IN AN ECONOMY

Inflation can result in positive or negative effects in an economy. These effects are discussed
below

1) Positive effects
a) Increase in production

Inflation makes people work hard in order to satisfy their needs, as they work, production
increases

b) Utilization of available resources

Inflation makes to make optimum use of the available resources in order to generate more
incomes and satisfy their needs

c) Motivates works

To cope with the effects of inflation, workers will be forced to work harder inorder to earn
more incomes and maintain their living standards

d) Benefits sellers

Sellers may earn more profits as a result of increase in market prices

e) Benefits debtors

In situations of inflation, sellers tend to benefit since the amount of money they pay back is less
in value than what they borrowed.

2) Negative effects
a) Reduction in profits
Sometimes an increase in prices may scare away buyers since they cannot afford products
whose prices have increased. This may lead to a reduction in firms’ profits.

b) Time wastage

A lot of time is wasted by consumers in window shopping for cheaper products

c) Discourages savings

With inflation, most of the money is spent in buying goods and services and very little is saved

d) Reduces confidence in money system

Inflation reduces people’s confidence in their monetary system since a lot of money is spent in
buying very few goods

e) Decline in the standard of living

Due to inflation, people are only able to afford few goods and services. This reduces their
standard of living.

f) Loss to creditors

Creditors tend to loose since the money they are paid by debtors is less in value than what was
lend out.

g) Slows economic growth

Inflation may create a situation where investors are not willing to take risks, open new
business, expand existing businesses or even hire more workers. This will greatly slow down the
rate of economic growth

h) Causes conflicts between employers and employees

During times of inflation workers through their trade unions pressurize employers to increase
their wages. This finally leads to strikes.

i) Adverse effects on the balance of payments

During times of inflation, exports become expensive leading to a fall in their demand. On the
other hand, imports from countries not experiencing inflation become relatively cheaper thus
increasing their demand. This implies that imports will exceed exports resulting in an
unfavorable balance of payment.

Losers in inflation
 a) Money lenders because they will get their money back at lower values
b) Pensioners because their savings will have been reduced in value
c) Savers since they will recover their money when it has lost value
d) Holders of long term bonds
e) Employees of long term contracts with fixed salaries
f) Landlords who are granted long leases at fixed rent
g) Employees who are paid mileage which is not renewed often

Gainers in inflation

a) Businessmen who buy stock in large quantities since they are likely to sell at higher
prices
b) Debtors because they will pay back less money in real terms
c) The government’s public debt because they will pay back in less value
d) Borrowers because they will pay back less in real terms

CONTROLLING INFLATION

Inflation is not desirable and for this reason, the government may adopt policies meant to
reduce or control it to manageable level. The following are some of these policies.

a) Monetary policies

These are measures which are targeted at controlling the supply of money in the economy.
Methods used are the tools of monetary policies which include:

i. Increasing the lending interest rate by commercial banks

ii. Selling government securities in the open market
iii. Increasing commercial banks cash or liquidity ratio
iv. Increasing compulsory deposits made by commercial banks in the central bank
v. Putting in place selective credit control measures
vi. Gives directives to commercial banks
vii. Requesting commercial banks to reduce the amount of money the lend to the public
b) Fiscal policies

Refers to the measures taken by the government to control inflation through taxation and
government expenditure adjustments. These measures include:

 Reducing government expenditure

A reduction in government expenditure reduces the supply of money in the economy hence
reducing inflation
  Increasing income taxes

An increase in income taxes reduces the amount of money at the consumer’s disposal therefore
reducing the supply of money in the economy which finally reduces inflation

 Giving subsidies

Subsidies reduces the cost of production enabling producers charge a lower price for their
products

 Reducing taxes on production inputs

A reduction in tax on production inputs reduces the cost of production therefore enabling
producers charge lower prices for their products.

 Reducing value added tax

Value added tax has a direct effect of increasing prices of affected products. A reduction in
these taxes will go a long way in reducing market prices

c) Statutory measures

Refers to the laws which the government passes to control inflation. These measures include:

I. Wage and salary control

Wage and salary control reduces the supply of money hence reducing inflation

II. Price controls

Through price control, the government sets prices beyond which certain products should not be
sold, as such inflation is controlled

III. Reduction of imports

A reduction in imports will go a long way in controlling imported inflation

IV. Controlling exports

Controlling exports reduces shortages hence preventing prices from rising

V. Restricting hire purchase and credit sales

Restricting hire purchase and credit sales will reduce demand for goods and services hence
preventing prices from rising
Effects of controlling inflation

a) May discourage investment since lowering prices reduces profit margins

b) Increasing taxes as a measure of controlling inflation may discourage production
c) Restricting imports as a measure of controlling imported inflation denies consumers a
variety of goods and services
d) Reduction of government expenditure reduces provision of essential services and goods
to citizens
e) Price controls may result in the emergence of illegal markets
f) Reducing the supply of money reduces investments, output and employment.

TOPIC 6: INTERNATIONAL TRADE

CONTENTS

 Introduction
 Advantages of international trade
 Disadvantages of international trade
 Terms of trade
 Balance of trade
 Balance of payments
 Terms of sale
 Documents used in international trade
 International financial institutions
 Economic integration
 Trade restrictions
 Foreign exchange rates
 Current trends in international trade

INTRODUCTION

International trade refers to trade between countries

It can be classified into two, namely:

 Bilateral trade
 Multi-lateral trade

Bilateral trade refers to trade between two countries whereas multi-lateral trade refers to trade
among many countries.
International trade involves exports and imports. Exports are goods and services sold to other
countries whereas imports are goods and services bought from other countries.

Reasons for international trade

a) Need to dispose surpluses

b) Desire by countries to acquire what they don’t produce
c) Desire to enhance international relations
d) Desire to acquire foreign currencies
e) Need to exchange skills and knowledge of producing certain goods
f) Desire to acquire high quality goods
g) Need for employment creation
h) To facilitate mobility of factors of production
i) To obtain a wider market for domestically produced goods and services

ADVANTAGES OF INTERNATIONAL TRADE

a) Enables a country obtain what it does not produce

b) Promotes peace and understanding among trading partners
c) Facilitates the transfer of technology from one country to another
d) Enables a country to fully exploit its resources in order to produce more goods
e) Goods can be obtained cheaply
f) Consumers in a country will enjoy a variety of goods and services
g) Promotes competition among countries hence making local producers improve the
quality of their products in order to remain competitive
h) Creates employment opportunities for a country’s citizens
i) Facilitates mobility of factors of production
j) Enables a country dispose its surplus
k) Earns revenue to a country through taxation
l) Facilitates specialization in production among countries

DISADVANTAGES OF INTERNATIONAL TRADE

a) May lead to collapse of local industries due to unfair competition from cheap imports
b) May result in imported inflation
c) Harmful products may be introduced into the country
d) Over-dependence on imports may compromise a country’s sovereignty
e) Over-reliance on imports may bring supply crisis during times of emergencies
f) May result in the introduction of bad cultural values as a result of interaction
g) Results in unfavorable balance of payments incase imports exceed exports
Reasons why international trade is difficult to conduct

a) Long documentation procedures involved

b) Various trade rules and regulations that differ from one country to another
c) Difficulties in identifying customers in far-away countries since there is no method of
sales promotion which is appropriate
d) Price fluctuations due to competition brought about by countries which are producing
similar goods
e) Differences in government policies and restrictions in different countries
f) Differences in cultural and social beliefs in different countries
g) Lack of trustworthy agents who are very necessary in international trade

TERMS OF TRADE

Terms of trade refers to the rate at which a country’s exports exchange against its imports.

Terms of trade = export price index ÷ import price index

Terms of trade may be favorable or unfavorable. They are favorable if exports exceed
imports and they are unfavorable if imports exceed exports.

Causes of favorable terms of trade

 Decline in the price of imports while those of exports increase

 Decline in the price of imports while those of exports remain constant
 Increase in price of exports while those of import remain constant

Causes of unfavourable terms of trade

 Increase in the price of while those of exports decline

 Decline in the price of exports while those of imports remain constant
 Increase in the price of imports while those of exports remain constant

Reasons for differences in terms of trade between countries (factors influencing terms of
trade)

Different countries experience different terms of trade because of the following reasons

a) Nature of the commodity exchanged

A country which exports cheaper products such as raw materials and imports manufactured
goods such as machines will spend more in importing than exporting, such country will
experience unfavorable terms of trade as compared to a country which exports manufactured
goods

b) Change in demand for exports

A country whose exports are highly demanded will fetch more money from international trade
as compared to a country whose exports are not demanded. Such country will have favorable
terms of trade.

c) Trade restrictions

Refers to measures put in place to control imports and exports. When a country restricts
imports, it will export more leading to favorable terms of trade. On the other hand, when a
country restricts exports, it will import more resulting in unfavorable terms of trade.

d) Supply of exports

When the supply of a country’s products is high in the international market, their prices will fall
as such a country will fetch less from exports resulting in unfavorable terms of trade and vice
versa.

e) Level of bargaining power

Economically powerful country which are able to influence decisions in the international
markets will have the prices of their exports increased enabling them fetch more from
international trade to favorable terms of trade.

BALANCE OF TRADE

Refers to the difference between the value of visible exports and the value of visible imports
over a given period of time usually a year.

Visible means goods that can be seen and touched

It is favorable when the value of visible exports exceeds the value of visible imports and is
unfavorable when the value of visible imports exceeds the value of visible exports

It is at equilibrium when the value of visible exports equals the value of visible imports.

BALANCE OF PAYMENTS

Refers to the difference between total imports (both visible and invisible) and total exports
(both visible and invisible)
It is favorable when total exports exceed total imports and it is unfavorable when total imports
exceed total exports.

Balance of payments account

This is a summary of the transactions which have taken place between a country and the rest of
the world over a period of time

There are three balance of payments accounts, these are:

 Balance of payments on current account

 Balance of payments on capital account
 Cash/foreign exchange transactions/official settlement account
a) Balance of payments on current account

Balance of payments on current account is the difference between the total values of exports
and imports (both from visible and invisible trade).

Balance of payment on current account = (visible exports + invisible exports) – (visible imports +
invisible imports)

(Illustration)

The account may be favorable, favorable or at equilibrium

b) Balance of payments on capital account

This is an account which records inflow of cash from other sources other than trade. These
inflows may include loans and grants whereas outflows may include loan repayments,
donations and grants to other countries

The difference between inflows and outflows is what is known as balance of payment on capital
account.

Balance of payments on capital account may be favorable, unfavorable or at equilibrium.

(Illustration)

c) The official settlement account

This is an account which is used to bring the balance of payment to the equilibrium. The
account summarizes all transactions that have taken place between a country and other
countries.

BALANCE OF PAYMENTS DISEQUILIBRIUM

Refers to situations when the balance of payment is either favorable or unfavorable

Causes of balance of payments disequilibrium

a) Fall in volume of exports

A decline in the volume of exports reduces export earnings resulting in a deficit in the balance
of payments

b) Increase in the volume of imports

When a country imports more goods, it spends more than it earns leading to a deficit in the
balance of payments

c) Deterioration of the terms of trade

When the value of a country’s import is higher compared to the value of exports, earnings from
international trade reduce resulting in a deficit in the balance of payments

d) Trade restrictions by the trading partner

When a country’s trading partner decides to take measures aimed at controlling its imports, the
country’s earnings from international trade will reduce resulting in a disequilibrium in the
balance of payments

e) Over-valuation of domestic currency

Over-valuation of domestic currency makes imports cheaper than exports hence reducing
earnings from international trade leading to a deficit in the balance of payments

f) Devaluation of a trading partner’s currency.

Devaluation of a trading partner’s currency makes its exports cheaper compared to its imports.
This reduces the value of exports a country makes to its trading partner leading to
disequilibrium

g) Less capital inflow compared to the outflow

A lesser capital inflow than outflow causes a disequilibrium in the capital account resulting in a
deficit in the balance of payments

Correcting balance of payments disequilibrium

Balance of payments disequilibrium can be controlled using the following measures

 1) Import control measures

These are measures which are aimed reducing the volume of a country’s imports. These
measures include:

a) Imposition of import duty

Imposing tax on imports will make imports expensive thereby reducing their demand

b) Imposition of import quotas

An import quota is a restriction on the amount of goods to be imported. Imposing import

quotas therefore will reduce the amount of goods to be imported

c) Complicating import procedures

Import procedures may be complicated by lengthening them or refusing to issue licenses. This
will discourage importation hence reducing the amount of goods imported.

d) Foreign exchange control

Refers to the control on the amount of foreign currency issued to importers to facilitate
importation. Such control will reduce the amount of imports.

e) Import substitution

Refers to the production of goods and services that can substitute imports. Such substitutes will
reduce the amount of imports

Advantages of import substituting

a) It helps create employment locally

b) It saves on foreign exchange
c) It promotes the utilization of local resources
d) It makes a country self-reliant
f) Subsidizing local industries

Giving subsidies to local industries enables these industries to produce more goods and services
resulting in the reduction of the amount of goods imported

g) Imposing total ban on imports

The government may totally ban all imports in a bid to control imports

2) Export promotion methods

These are methods which are targeted at increasing the volume of goods exported. These
methods include:

a) Removal of trade restrictions

The government can remove all restrictions on exports e.g. reducing tax on exports. This will
encourage exports

b) Export compensation scheme

This is a scheme from where an exporter is refunded part of the expenses incurred in exporting.
This will reduce the cost of exporting hence encouraging exports

c) Offering customs drawbacks

Refers to refund of customs duty. If a trader imports raw material to manufacture goods for
export and pays customs duty in the process, such customs duty will be refunded by the
government if the finished goods are exported. This will encourage exports.

d) Intensive marketing

Through marketing, a country’s exports in foreign nations can be promoted hence increasing
the volume of exports.

3) Encouraging foreign investment

By encouraging foreign investments, local people are able to access a variety of goods and
services hence reducing imports. The surplus can also be exported to earn income to the
country.

4) Restricting the outflow of capital

The government can control the outflow of money through non trading activities. This can be
done by controlling donations thereby ensuring equilibrium in the balance of payments

5) Devaluation of currency

Devaluation makes a country’s currency cheaper to foreign nations. Exports will therefore
become cheaper since foreign importers will pay less to acquire local goods. This will boost
exports

TERMS OF SALE IN INTERNATIONAL TRADE

Terms of sale refers to the price quotation that states the expenses the expenses that are paid
by the exporter and those that are paid by the importer.
The following are the common terms of sale in international trade

a) LOCO/ex-warehouse/ex-works

The buyer pays for the goods as they are in the exporter’s warehouse and incurs all the
expenses of moving goods to his destination

b) Free on Rail(F.O.R)

The seller will meet the cost of moving goods up to the nearest railway station. The price paid
by the buyer will therefore include the expenses incurred in moving goods to the nearest
railway station.

c) Delivered docks/free docks

The price charged for the goods includes all the expenses involved in transporting goods to the
nearest dock.

NOTE: a dock is a place where ships wait for cargo

d) Free alongside ship( F.A.S)

Price charged for the goods includes all the expenses incurred in transporting goods to the dock
plus all dock charges such as storage costs.

e) Free on board( F.O.B)

Price charged for the goods includes all expenses incurred up to the point where the goods are
in the ship ready to be transported to their destination

f) Cost & freight( C&F)

Price charged for the goods includes all the loading and carriage expenses

g) Cost insurance and freight

Price charged includes all the loading, carriage and insurance expenses

h) Landed

Price charged includes all the expenses incurred from the seller’s premises to the port of
destination including offloading charges

i) In bond
The price charged includes all expenses incurred until the goods are delivered to the bonded
warehouse.

j) Franco(free of expenses)

The price charged for the goods incudes all the expenses incurred until the goods are delivered
to the buyer’s premises

h) O.N.O(on nearest offer)

The buyer is willing to accept the quoted price or any other price near to the quoted price.

DOCUMENTS USED IN INTERNATIONAL TRADE

a) Letter of credit

This is a document which allows the importer get goods on credit from the exporter. It affirms
the amount due will be paid.

It is sent by the importer’s bank to the exporter’s bank

It can be revocable or irrevocable. It is revocable if it can be withdrawn without the approval of

the exporter. It is irrevocable if it cannot be withdrawn without the approval of the exporter.

b) Import license

This is a document which gives permission to a person to import goods

It is issued by the relevant government authority after all requirements have been complied.

c) Indent

This is an order sent by the importer to the agent in a foreign country requesting for goods

It can be open or closed. It is open when the importer has not specified the name of the
manufacturer to supply the goods hence the agent is free to look for a suitable supplier. It is
closed when it clearly states the type of goods required and the manufacturer from whom
goods should be bought.

d) Bill of landing

This is a document when goods ordered are loaded into the ship and it serves the following
purposes

 Acts as evidence that goods have been received by the ship owner
  Acts as evidence of the agreement between the ship owner and the shipper
 Enables the named therein or his agent to claim the goods when they arrive
 It is used to counter-check goods on arrival
 It is used to claim compensation in case all goods indicated are not delivered
e) Policy/certificate of insurance

This is a document that acts as evidence that goods have been insured

f) Certificate of origin

This is a document which is prepared by the exporter giving details of the exported goods and
their country of origin. The document is usually signed by the relevant authority in the country
of origin.

The purpose of this document is to enable the importer get preferential treatment on the
goods imported especially if they originate from a country which is a member of the trading
bloc.

g) Airway bill

This is a document which is prepared when goods are transported by air. It shows the charges
the importer is to pay to the airline company

h) Commercial invoice

This is a document which is prepared by the seller to demand for payment. It is similar to the
local invoice and it contains

 Name and address of the exporter

 Name and address of the importer
 Price of the goods delivered
 Terms of sale
 Description of the goods
 Name of the transporter
i) Consular invoice

This is a document which shows that prices charged for the goods are fair as certified by the
importing country’s officials or a representative in the embassy of the exporting country

This document enables customs officials charge the correct duty.

j) Proforma invoice
This is an invoice which is used to serve the following purposes

 Serves as a quotation
 Requests for payment before goods are delivered
 Enables the importer to get customs clearance before goods arrive in the country
 May be used by the importer to obtain permission to import goods
 It shows the prospective importer the amount of money he/she will be expected to
pay when goods are finally delivered
 It cautions the importer that the exporter does not intend to sell on credit
k) Freight note

This is a document which is prepared by the shipping company to show the charges for shipping
the goods

l) Letter of hypothecation

This is a letter written by the exporter to his bank authorizing it to resell the goods being
exported. This is if the importer fails to pay the amount due.

m) Weight note

This is a document which states the weights and other measurements of goods delivered to the
docks

n) Shipping advice note

This is a document which is issued by the exporter to the shipping company containing
instructions for shipping the goods

INTERNATIONAL FINANCIAL INSTITUTIONS

Some of the international financial institutions which are important players in the international
monetary system include:

 International monetary fund( I.M.F)

 African development bank( A.D.B)
 African development fund(A.D.F)
 International bank for reconstruction and development(world bank)
a) International monetary fund

It was formed at a conference in Bretton woods in 1944. It is a central bank of central banks of
all member countries. Its functions include:
  Maintaining stable exchange rates among member countries
 Promote co-operation among member countries
 Extension of financial aid to member countries
b) The African development bank

It was established in 1964 to promote economic development and social progress of its
member countries

Its headquarters are in Abidjan-Ivory coast.

Its functions include:

 Provision of loans to member countries

 Provision of technical advice in economic development
 Assists member countries to fully exploit their resources
 Encourages cooperation among member countries
 Cooperates with other financial institutions to bring about development in Africa.
c) African development fund

It was established in 1972

Its main objective is to provide long-term financial assistance to developing countries

It also funds education and research activities apart from offering technical advice

d) The world bank

It was created in 1944 by the Bretton woods conference

Its functions include:

 Giving loans to member countries

 Guarantees member countries taking loans from other financial institutions
 Provides technical advice and assistance to member countries
 Makes a follow up to make sure that finances given to member countries are put to
intended uses
 Giving grants member countries to finance development projects

NOTE: For a country to be a member of the World Bank, it must be a member of IMF

ECONOMIC INTERGRATION

Refers to economic cooperation among member countries

It is achieved by achieved by allowing free trade or by relaxing trade barriers among countries

Forms of economic integration

a) Free trade area

In free trade area, countries agree to relax or abolish trade barriers among themselves leaving
each individual country to impose its own trade restrictions on non-member countries e.g.
P.T.A.

Its features

b) Free trade among members is achieved through minimizing trade restrictions

c) Individual members are free to impose their own trade restrictions (tariffs) on non-
members
d) There is freedom of movement of consumer goods and services
e) Movement of factors of production is restricted
f) Customs union

In customs union, countries relax or abolish trade barriers among themselves as they impose a
common tariff on trade to all non-member countries

Its features

a) Members impose a common tariffs on non-member countries

b) An individual country’s interest does not override the interest of the union
c) Member countries agree to allow free trade among themselves
g) Common market

In a common market, member countries relax or abolish trade barriers amongst themselves as
they impose uniform tariff on trade with all non-members. Factors of production are also free
to move from one country to another

Its features

a) There is free trade among member countries

b) Common tariffs are imposed on non-members
c) Factors of production move freely across borders
d) There is development of common social and capital infrastructure
h) Economic union

It has all the features of a common market in addition to establishing joint financial institutions
and using a common currency and communication networks.
Its features

a) There is free trade among members

b) Common tariffs are imposed on non-members
c) There are common monetary and fiscal policies
d) A common central bank
e) A single currency is adopted
f) Adoption of joint economic institutions such as stock market

Importance of economic integration to a country (Benefits of free trade)

a) Availability of market

A country will enjoy a wider market for its products. This will enable a country increase its
production capacity

b) Creates employment

As factors of production move freely, they are able to get employment elsewhere.

c) Encourages specialization

A country is able to concentrate on the production of those goods which it is best suited at. This
will finally lead to optimum utilization of available resources

d) Development of industries

Industries may develop in order to produce goods and services for exports

e) Common bargaining front

Countries may enjoy a high bargaining power when they negotiate prices with non-member
countries. This brings about better trading terms for members

f) Production of high quality and cheap goods

Through specialization, a country produces high quality and cheap goods. This may also be
made possible by competition which is brought about by international trade.

g) Promotion of peace

Members within a given trading bloc will co-exist harmoniously with other members as they
interact in trade.

Disadvantages of economic intergration

 a) Loss of revenue

Revenue from customs duty may be lost through tariff waiver

b) Limits consumer choice

Consumers may lack variety of goods to choose from if the country only trades with members
of the trading bloc.

c) Harm to local industries

Cheap imports may flood the domestic market leading to unfair competition that may make
local industries to close down

d) Causes unemployment

If more skilled foreigners move to the country in search of jobs, they may take all jobs leaving
the locals unemployed

e) Comprises a country’s sovereignty

A country may be compelled to change its laws in order to fit in a trading bloc. This will greatly
compromise its political sovereignty.

f) Loss of opportunity to obtain cheaper goods

A country is denied the opportunity to buy goods outside the trading bloc which may be
cheaper and of high quality.

Benefits of being a member of a trading bloc

a) Citizens are able to access a wide variety of goods and services

b) Citizens are able to buy goods and services at lower prices. This is because customs
duties may be reduced or abolished
c) The country enjoys a wider market for its goods and services
d) There is free movement of factors of production among member countries which
reduces unemployment
e) Member countries can enjoy external economies of scale
f) Friendship ties develop among member countries which brings about international
peace and understanding

Reasons why trade agreements may not be fully achieved

a) Nature of products
Most countries produce similar products which make it difficult to trade with one another

b) Difference in currencies

Some currencies are superior to others to the extent that they make trade between the
countries affected very difficult

c) Political instability

Some countries have internal political problems which make it difficult for them to fully
participate in trade

d) Lack of funds

Some member countries fail to meet their financial obligations to the agreement’s secretariat
hence are not allowed to engage in trade with other members

e) Poor infrastructure

Poor infrastructure among member countries hinders the movement of goods and services
from one country to another hence making trade difficulty

f) External interference by non-member countries

Non-member countries may interfere with the internal affairs of member countries by imposing
conditions that are not conducive for trade

g) Differences in levels of development

Member countries may be at different levels in development making some countries feel that
they are not benefitting mutually from trade with other member countries

TRADE RESTRICTION

Refers to imposition of measures/barriers aimed at restricting trade among countries

It is also referred to as “trade protection” or “protectionism”

Reasons (advantages) for trade restriction

a) Protection of local infant industries

Trade restriction protects local infant industries from unfair competition from established
foreign industries which are able to sell goods at a cheaper price hence controlling the market

b) Promote self-reliance
Through trade restriction, local producers may be encouraged to increase their productivity in
order to ensure a constant supply of goods and services so as to avoid over-reliance on imports
which may not be available during times of emergencies

c) Protection of strategic industries

Strategic industries are the very important industries to the country such as those providing
security. The country needs to protect these industries to ensure they don’t over depend on
foreigners. To do this, the government has to restrict foreign trade.

d) Expansion of market for local products

Discouraging imports increases demand for local products.

e) Discourage dumping

Dumping refers to a situation where a country disposes its products cheaply in another country.
Dumping brings about unfair competition to local industries hence has to be discouraged.

f) Creation of employment

Discouraging imports encourages local industries to emerge in order to produce goods that
could have been imported. These industries will contribute to employment creation.

g) Preservation of the balance of trade

Discouraging imports ensures the balance of trade is always favourable.

h) Protection of cultural and social values

Trade restriction controls the adoption of harmful cultures from foreign countries through
interaction during trade activities.

Disadvantages of trade restriction

a) Emergency of monopolies

Over protection of local industries may lead to their expansion to the extent of them becoming
monopolies that may exploit local consumers through charging them high prices for the goods
they produce.

b) Reduces variety of goods and services

Fewer goods and services will be available to consumers due to discouragement of imports
 c) Prevents growth of local industries

Overprotection of local industries may make them reluctant to compete with foreign industries
hindering their growth

d) Imposition of restrictions by a trading partner

Imposing trade restrictions on imports from a trading partner may make the trading partner
reiterate by imposing restrictions on a country’s exports

e) Production of low quality goods

Over protection of local industries makes them reluctant to compete hence they cannot
produce high quality goods

f) High prices for local products

Due to trade restrictions, cheap imports may not enter the country hence locals will be forced
to buy expensive locally produced goods

g) Results in reduced exchange earnings due to reduced exports

h) Results in shrinking markets due to reduced volume of trade
i) Prevents the transfer of technology in production which may lead to the production of
low quality goods and low output
j) Leads to poor international relations which may lead to conflicts among countries
k) Leads to increased unemployment due to reduced trading activities
l) Leads to low investments due to reduced trading activities

Methods of trade restriction

a) Tariffs

Tariffs are taxes charged on imports or on exports e.g. import and export duties

Tariffs increases the cost of importation or exportation resulting in lesser imports and exports

b) Quotas

Quotas refer to a limit on the value or amount of a commodity to be imported or exported. A

zero quota is known as an embargo.

Quotas reduce the amount of imports and exports hence restricting trade.

c) Foreign exchange control

Refers to restriction on the amount of foreign currency importers should access at a given time.
Such a restriction will reduce the amounts of imports.

d) Complicated procedures

The government may put in place complicated import or export procedures. Such procedures
discourage importation and exportation

e) Moral persuasion

The government may request traders to willingly reduce the amount of goods they import or
export

FOREIGN EXCHANGE RATES

Refers to the rate at which different countries’ currencies are exchanged with each other in
order to facilitate international trade

Types of exchange rate systems

a) Fluctuating exchange rate system

It is also referred to as flexible or floating exchange rate system. This is a system where
exchange rates are determined by forces of demand and supply

Disadvantages of floating exchange rates

 It may lead to inflation

 It may discourage foreign investors since there is no certainty on returns to investments
 It makes citizens lose confidence in their local currency making them to hold their
wealth in other forms other than in monetary form
 It inhibits credits from foreign financiers since they are uncertain about the value of
loans and the interest payable
 It discourages exporters since they do not know about the revenue they expect to earn
when their foreign earnings are repatriated
 It inhibits international trade therefore the benefits of international trade are not
enjoyed by concerned countries
b) Fixed exchange rates

According to this system, values of currencies are fixed in terms of a common denominator

c) Adjustable peg system

According to this system, countries agree on a fixed exchange rate but also tolerate variations
 TRENDS IN INTERNATIONAL TRADE

a) Liberalization

Liberalization refers to the removal of trade barriers among countries in order to allow free
trade. Modern international trade has seen the removal of most barriers to trade.

Advantages of liberalization

 Enables consumers to get varieties of goods and services from all over the world
 Enables producers to get the best price for products since they are free to sell their
goods at any part of the world
 Enables the country avoid shortages since it can import goods from all over the world
 Consumers get competitive prices from different sellers who are competing for the
market
b) Export processing zones

These are areas set aside by the government where industries producing goods specifically for
export can be set up. Products from such industries are exempted from tax for a specific period
of time. Besides E.PZs have well developed infrastructure.

Advantages of E.P.Zs

 Provides exports which correct unfavourable terms of trade

 Encourages industrialization
 Earns revenue through taxation
 Creates employment opportunities
 Creates market for locally produced raw materials which are used to produce exports
 Encourages foreign investors into Kenya

Disadvantages of E.PZs

 May promote social evils such as prostitution

 May not provide employment opportunities to the locals since they mostly employ
foreigners
 Do not earn revenue to the country during the tax free period
 Brings about imbalance in development since they are only created in selected regions

Ways in which the government promotes EPZs

 Improving infrastructure in EPZ regions

 Providing adequate security in EPZ regions
  Providing tax holidays for businesses operating in EPZ areas
 Providing cheap or free land to EPZ businesses
c) E-commerce

Refers to trading through the internet. Payments are effected through EFT or western union
money transfer.

TOPIC 7: ECONOMIC DEVELOPMENT AND PLANNNG

CONTENTS

 Introduction
 Indicators of economic development
 Economic under-development
 Goals of development
 Factors hindering development
 Development planning

INTRODUCTION

Economic growth: refers to the increase in a country’s productivity resulting in the rise in
National income over a given period of time.

Conditions necessary for economic growth

 There should be good capital formation and creation from investments and savings
 Output rates should be high enough to sustain production and growth levels
 Population growth rate should not be higher than the capital growth rate
 Presence of favourable micro and macro-economic policies e.g. monetary policies of a
country must be fair
 There should be aggressive marketing of a country’s products abroad
 Adoption of modern technology which reduces cost of production and improves quality
 There should be a well-developed and strong entrepreneurial culture
 There should be an Improved infrastructure
 Ensuring the country is politically stable

Economic development: refers to improvement in the standard of living which is brought about
by increase in National income.

Differences of economic growth and economic development

Economic growth Economic development

Refer to a quantitative increase in the size of
national income
Does not account for the distribution of
wealth
Measured in terms of annual changes in GNP
There can be economic growth without
economic development
Refers to both quantitative and qualitative
improvement in the country’s production
Accounts for the distribution of wealth
Measured on the basis of the people’s well
being
Economic growth brings about economic
development hence the two go hand in hand

INDICATORS (characteristics) OF ECONOMIC DEVELOPMENT

 Shifting from reliance on agriculture to relying on manufacturing

 Increase in the level of literacy
 Improvement in medical care services
 Increase in the number of skilled manpower
 Use of modern technology in production resulting in high quality products
 Increase in level of entrepreneurship
 Low population growth rate
 High levels of per-capita income
 Well-developed infrastructure

Factors which hasten economic development

a) Improved infrastructure and social amenities

b) Industrialization
c) Improving research and development
d) Educating and training
e) Use of modern technology in production
f) Improved medical facilities
g) Good governance
h) Good natural resource endowment
i) Presence of strong entrepreneurial culture

ECONOMIC UNDER-DEVELOPMENT

Refers to a situation where there is a decline in the standard of living in a country.

Characteristics of under-development

a) Increase in level of poverty

Under-developed countries have lower per-capita incomes which results in poverty that is
reflected by a decline in the standard of living.

b) High dependency level

Under-developed countries tend to depend to a large extent on developed countries for

financial aid since they cannot sustain themselves financially

c) Poor infrastructure

Infrastructure such as roads and communication networks are poorly developed in under-
developed countries. This s due to lack of adequate finances to improve on such infrastructure.

d) Low labour productivity

The level of output from production in under-developed countries is extremely low. This is as a
result of poor quality complimentary factors such as tools and management

e) Out-dated cultural practices

People in under-developed countries tend to resist change; as a result they continue embracing
the old and outdated cultural practices which do not promote development

f) Disparity in income distribution

Incomes in under-developed countries are unequally distributed since the few rich people own
a big proportion of national income leaving a small proportion to very many poor people. This
results in poor living standards

g) Low level of savings and investments

Due to low per-capita income, people in under-developed countries have little incomes to save.
As a result level of investment will decline leading in the vicious circle of poverty as shown
below

Low savings---low investments---low capital formation---low income---poverty

h) Under-utilization of natural resources

Lack of adequate capital, personnel and appropriate technology makes resources in under-
developed countries remain under-utilized. This will greatly hinder development

i) High population growth rate

The rate at which population grows in under-developed countries is very high. This is due to the
fact that such countries still embrace outdated cultural practices which emphasizes on a large
family. Such large population contributes to high poverty level

j) Unemployment

The rate of unemployment is relatively higher in under-developed countries. This may be as a

result of under-utilization of resources and low levels of investment.

k) Dominance of the subsistence sector in the economy

Many people in under-developed countries produce goods and services for personal
consumption and not for sale. This reduces the level of incomes resulting in poverty.

GOALS OF DEVELOPMENT

Goals of development are the reasons for economic development. Such goals include:

 To eliminate or reduce poverty

 Reduce level of unemployment
 Reduce disparities in income distribution
 Provide basic needs such as food, shelter, health and protection
 Improve the standard of living
 Provide employment and advancement opportunities
 Increase productivity
 Improve efficiency of socio-economic institutions such as education and health
 Provide a conducive environment for technological advancement
 Reduce economic dependence
 Improve efficiency in production
 Provide a variety of goods and services to consumers
 Promote international cooperation

FACTORS HINDERING DEVELOPMENT

a) Low natural resource endowment

Lack of adequate natural resources such as land, favorable climate, raw materials etc. may be a
barrier to development.

b) Poor technology

Poor technology leads to lower productivity resulting in under-development

 c) Inadequate capital

Capital refers to finances and tools used in production. When capital is inadequate, resources
will be under-exploited leading to lower productivity resulting in under-development

d) Poor human resource endowment

Human resource refers to the country’s workforce. When this workforce is lacking specialized
skills, productivity will be extremely low which results in under-development.

e) Unfavorable environment

Environment is influenced by political, social and economic factors. These factors are discussed
below:

 Political factors: refers to factors which are brought about by a country’s political
institutions. Where the government is corrupt, corrupt or authoritarian, investors may
be scared
 Social factors: these are made up of a country’s cultural values and attitudes which are
not conducive for development. Development may be hindered if the society is resists
change or has a negative attitude towards work. Extend families may also hinder savings
leading to low investment levels
 Economic factors: economic factors refer to markets which include commodity markets,
labour markets and financial markets. In a market where free market factors don’t
operate smoothly, entrepreneurship may be negatively affected.

DEVELOPMENT PLANNING

Planning is a process through which one focuses on the future. Development planning
therefore is a deliberate government effort aimed at influencing and improving the economy of
a nation.

Qualities of a good development plan

a) It must be all inclusive i.e. all stakeholders must be involved in planning

b) It should address current issues affecting the country
c) Its objectives should be explicitly stated in simple and clear terms
d) It should be realistic and achievable
e) It must be broad in strategy i.e. contains other strategies that will be used to achieve set
goals

Stages of development planning

 a) Establishing objectives to be achieved e.g.
 Improving literacy levels
 Improving health standards
 Raise standard of living
 Reduce foreign dominance etc.
b) Identifying the resources required to achieve the objectives
c) Establishing methods of achieving such objectives

Reasons for development planning

a) Appropriate allocation of resources

Through planning, a country is able to allocate its resources in a productive way so as to ensure
optimum utilization

b) Evaluation of implemented projects

Planning enables the government to determine whether projects are in line with expected
outcomes. Deviations are identified and corrected immediately.

c) Stimulation of efforts

The government can use planning to direct the efforts of its people towards achieving laid down
objectives

d) Influencing donors

A good plan may be used by the government in soliciting for donor funding. The plan enables
donors to be able to see the policies the government has put in place in order to meet certain
objectives

e) Facilitating long-term decision making

A development plan will enable the government make effective decisions on how to achieve
certain objectives

f) Promoting balanced regional development

Through planning, the government is able to distribute industries in every part of the country in
order to ensure equitable regional development

g) Avoiding duplication of industries

A plan will enable the government to avoid a situation where there are industries
manufacturing the same product so as to ensure that citizens have access to a variety of
products.

Problems encountered in development planning

Development planning involves two major stages, namely:

 Plan formulation stage

 Plan implementation stage

Problems at plan formulation stage

a) Lack of accurate and well detailed data

When statistical data which aids in planning is either unavailable or inaccurate, the quality of
the plan is negatively affected

b) Existence of large subsistence sector

Existence of a large subsistence sector makes planning unrealistic

c) Lack of qualified personnel

Due to lack of locally qualified personnel, many less developed countries rely on foreign
experts. Many of these foreign experts may not be familiar with the local plans

d) Existence of the private sector

Private sector enterprises may be pursuing different objectives from the government’s
objectives. This makes achievement of plans impossible.

e) Transfer of inappropriate development plans

Plans copied from developed countries may fail to work in developing countries thereby making
planning impossible

Problems at plan implementation stage

a) Over-reliance on donor funding

Developing countries in many cases depend on developed countries to fund their plans . if this
aid is not released, implementing plans becomes a problem.

b) Natural calamities
Natural calamities such as diseases drought or floods, makes the government to direct money
meant for plan implementation to countering these calamities thereby affecting plan
implementation negatively.

c) Lack of required resources

Lack of resources such as skilled personnel, finance and equipment, may hinder
implementation of plans

d) Non-involvement of the local people

In most cases local people are used by the government to implement its plans, failure to involve
the local people therefore makes implementation difficult

e) Lack of political will

Without political willingness and commitment, plan implementation becomes difficult

f) Setting over-ambitious plans

Some plans cannot be implemented since they are unachievable especially if they are meant to
impress donors

g) Inflation

Inflation increases the cost of acquiring resources required to implement plans. This negatively
affects plan implementation

h) Lack of co-operation among parties involved

Without co-operation amongst parties executing the plan, implementation is made difficult.