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Learning Objectives
A study of this chapter should enable students to:
Describe what accounting is all about
Understand the nature and scope of accounting
Highlight the main users of accounting information and their interest in it.
Outline the purpose and objectives of accounting
Identify the various specializations of accounting
This chapter discusses what is accounting; its nature and scope with a historical background.
Accounting information is used by various users with particular interests and this chapter will
capture this and lastly show the different branches of accounting.
The Nature, Scope, and Purpose of Accounting
To account is to render an explanation. The American Institute of Certified Public Accountants
(1961) defined accounting as the art of recording, classifying and summarizing in a significant
manner and in terms of money, transactions and events, which are, in part of at least of a
financial character, and interpreting the results thereof’
The Accounting Standards Board (1991) on the other hand has defined accounting as the
provision of information about the financial position, performance and financial adaptability of
an enterprise that is useful to a wide range of potential users in making economic decisions”.
Prof N.D Nzomo in Basic Accounting defines accounting as the art and science of recording
transactions, processing the recorded transactions into a comprehensible form and
communicating the information to interested parties.’
The American Accounting Association (1966) defined accounting as the process of identifying,
measuring and communicating economic information to permit informed judgments by users of
The definition provided by the American Institute of Certified Public Accountants (AICPA)
focuses more on the procedures of accounting while the definition provided by the Accounting
Standards Board (ASB) focuses on the purpose of accounting.
The underlying purpose of accounting as implied in the definition provided by ASB is to provide
information about an economic entity to individuals to aid them in the making of economic
decisions. It may be useful to emphasize at this juncture that the role of financial accounting
and reporting in the economy is to facilitate the making of commercial and economic decisions
but not to determine what those decisions should be (N.D Nzomo, Advanced Financial
Accounting, Kenya Literature Bureau, Nairobi; 1992 pp.1).
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The use of accounting is not limited to the business world. Rather, virtually everyone engages in
a form of accounting. Individuals must account for their incomes and file income tax returns.
This is now mandatory for every person even if employment is the only source of income and
Pay as You Earn (PAYE) is the final tax. Individuals often have to supply personal accounting
information to financing institutions to qualify for loans or obtain credit. The central
government, local authorities, educational institutions, religious organizations use accounting
information as a basis of operations, measuring accomplishments and performances as well as
controlling their resources. The study of accounting is therefore not limited to those engaged in
accounting or finance but to everyone who engages in economic activity. Accountants serve
decision makers by providing them with financial information about an economic entity.
Accounting as a social science lends itself easily to its analysis as an information system. It has
the attributes of a system;
(i) It has a basic goal, which is to provide information,
(ii) It has clear and well defined elements in the form of people and equipment, and
(iii) It has the typical activities of a system, namely; input, process and output.
An important aspect of accounting as an information system is the definition of its boundaries.
The first boundary is the filtering process by which the accountant selects data. The filtering
process is provided by the conventions of accounting, which play a deterministic role in defining
accounting information. The second boundary is established by specific information needed of
its users. The output requirements determine the type of data selected as the input. Control refers
to the extent to which users’ needs should determine not only the nature of data input but also
the extent of the data input which should be determined by a cost benefit analysis. The output of
the system is the financial statements and reports.
The task of the accountant is therefore to transform raw data into information; a form that has
meaning and is able to influence decisions.
The analysis of accounting as an information system enables us to make some important
(i) The goal of the system is to provide information which meets the needs of its users.
(ii) The output requirements determine the type of data selected as the input for processing
into information output.
Users of accounting information are varied and they use accounting information in order to
satisfy some of their different needs for information: They include:
Present and Potential investors
The providers of risk capital and their advisers are concerned with the risk inherent in, and return
provided by their investments. They need information to help them determine whether they
should buy, hold or sell. Shareholders are also interested in information which enables them to
assess the ability of the enterprise to pay dividends. Profitability and financial soundness would,
therefore, be matters of prime importance to them.
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Lenders, suppliers and other creditors
These are entities that have extended or consider extending loans or credit. Lenders are
interested in information that enables them to determine whether their loans and the interest
attaching to them will be paid when due.
Suppliers and other creditors are interested in information that enables them to determine
whether the amounts owing to them will be paid when due. They will be concerned about the
liquid assets of an enterprise relative to the amount of liability falling due in the near future, and
about the owner’ s investment relative to outside funding. To the lenders, suppliers and other
creditors, owner’ s investment serves as a protecting buffer between lenders, suppliers and other
creditors and any losses which may befall the enterprise.
Employees and their representative groups are interested about the profitability and stability of
their employers. They are also interested in information which enables them to assess the ability
of enterprises to provide remuneration, retirement benefits and employment opportunities.
Management requires accounting information to assist them in discharging their managerial
function. The management process may be analyzed into three major functions planning,
organizing and controlling the activities of the enterprise. These various management functions
have one thing in common: they are all concerned with making decisions.
Governments and their agencies
Governments and their agencies are interested in the allocation of resources and therefore the
activities of enterprises. They also require information in order to regulate the activities of
enterprises, determine taxation policies and as a basis for national income and similar statistics.
These will include employment, provision of goods and services and the contribution of
enterprises to socio– economic development.
Customers have an interest in information of an enterprise indicating the continuance of an
enterprise especially when they have a long-term involvement with, or are dependent on the
entity. Customers would also be concerned about the fairness of pricing policies, differential
costs between one product and another produced by the same firm at a different price.
Enterprises compare their performance with those of other enterprises. They assess their position
against their competitors. Financial statements enable them to know profit margins, value of
assets, and resource utilization among other items of their competitors.
The general public requires information on the activities of enterprises in light of social benefits
and costs that accrue to the community. The public is very dependent on enterprises not only
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because they provide employment but because they affect the entire socio-economic structures of
the environment. Firms provide employment; create demand for local services, as well as
extensions in the provisions of welfare services as the economic well being of the community
Specializations of Accounting
To meet the varied needs of users of accounting information accounting has developed
specializations and sub-specializations. These include the following specialized fields each with
its own area of expertise, responsibility as well as educational requirements;
1. Financial accounting. 6. Human Resources Accounting
2. Managerial accounting. 7. Social Accounting
3. Tax accounting. 8. Environmental Accounting
4. Fund accounting 9. Forensic Accounting
5. Auditing 10.Behavoiral accounting
Two requirements that are shared by all these fields are a sound mathematical background and an
understanding of business and economic environment.
1. Going concern
It is assumed that the business will continue to operate on a continuous process without
a possibility of ceasing in future hence the term going concern. Therefore, financial
information and statements are prepared on the assumption the business is a going
2. Accrual concept
The effects of transactions and other events are recognized when they occur and they
are recorded in the books and reported in the financial statements of the period to
which they relate e.g. revenues in a particular year should be matched to expenses in
the same period that were used to generate the revenue
3. Money Measurement Concept
Concept states that accounting information is measured in monetary units i.e.
transactions are valued in monetary terms
4. The business entity concept
implies that the affairs of a business are to be treated as being quite separate from the
non business activities of its owners e.g. when the owner pays school fees using own
resources such transaction can never be recorded in business books of account. But
when the owner brings additional capital or makes drawings such transactions touches
on the business and therefore must be recorded.
5. The time interval concept
Financial statements should be prepared at regular intervals usually one year.
6. Historical cost concept
Concept means that Assets are normally shown at cost price and that this is the basis for
valuation of the assets
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7. The dual aspect concept
This states that there two aspects of accounting, one represented by the assets of the
business and the other by the claims against them. The concept states that these two
aspects are always equal to each other. I.e. Assets = Capital + liabilities
8. The prudence concept
Requires that the financial statements are neutral that is that neither gains nor losses
should be overstated or understated. Accountants should always exercise caution when
dealing with uncertaininty while, at the same time ensuring that the financial
statements are neutral e.g. when making decision on bad debts
9. The consistency concept
Measurement and display of the financial effect of similar transactions and other events
must be done in a consistent way throughout an entity and over time for that entity,
and in a consistent way for different entities.
10. Materiality concept
Information is material if its omission or misstatement could influence the economic
decisions of users. Everything that appears in financial statements should be material.
11. Objectivity/ Neutrality concept
Information in financial statements must be free of bias
12. The realization concept
Holds to the view that profits and gains can only be taken into account when realization
has occurred and that realization occurs only when the ultimate cash realize is capable
of being assessed e.g. when sales have been made.
13. Substance over form concept
Transactions and other events must be accounted for and presented in accordance with
their substance and economic reality and not merely their legal form e.g. a car bought
on hire purchase does not belong to the owner legally, but the business uses it to
generate revenue for the business as if it was owned by the business
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Learning objectives
A study of this chapter should enable students to:
Explain what is meant by the Accounting Equation
Have a clear perspective of the double entry system
Understand how the double entry system follows the rules of the accounting equation
Describe the debit and credit entries with corresponding transactions
Accounting for Assets, Liabilities and Capital
Accounting for Sales, Purchases, Incomes and Expenses
Understand the Asset of Stock
This chapter introduces the application of the Accounting Equation that forms the basis of the
double entry in accounting. Debit and credit entries are used in accordance to a particular
transaction and for the double entry to be observed, every debit entry must be corresponded with
a credit entry or a set of credit entries and vice versa.
The Accounting Equation
Initially when a business enterprise starts operating, it owns property inform of assets that are
equivalent to the start up capital. Later on after continuance in the business, obligations inform of
liabilities are incurred hence the equation changes. The total assets are now equivalent to the
capital plus the liabilities in the business.
The accounting equation is summarized in the balance sheet as illustrated below;
(Horizontal Format) Balance sheet as at 31.12.20x3
Non Current Assets Capital xxx
Land and buildings xxx
Furniture and fittings xxx Long term liabilities
Less Acc Depreciation (xx) 5 year loan from ABC ltd xxx
Motor vehicles xxx
Less Acc Depreciation (xx)
Current Assets Current Liabilities
Debtors (A/c Receivable) xxx Creditors (A/c Payable) xxx
Stock (Closing Inventory) xxx Bank overdraft xxx
Prepaid Expenses xxx Accrued expenses xxx
Bank xxx xxx
Cash xxx
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Activity 1
The following transactions demonstrate the application of the accounting equation in a balance
1.) Introduction of Capital for a New Business
01/01/20x3; XYZ traders started business by depositing Ksh 90,000 in a business bank account
Balance sheet as at 01/01/20x3
Cash at bank 90,000 Capital 90,000
90,000 90,000
2.) Purchase of a Non Current Asset via Cheque
04/01/20x3; XYZ bought a motor vehicle for the business worth Ksh 40,000 paying by cheque
Balance sheet as at 04/01/20x3
vehicle 40,000 Capital 90,000
Cash at bank 50,000
90,000 90,000
3.) Purchase of a Current Asset on Credit
07/01/20x3; XYZ purchased goods for Ksh 13,000 on credit terms.
Balance sheet as at 07/01/20x3
40,000 Capital 90,000
Stock 13,000 Liability
Cash at bank 50,000 Creditor 13,000
103,000 103,000
4.) Sale of a Current Asset on Credit Terms
11/01/20x3; XYZ made credit sales costing Ksh 5,000 to ABC enterprises.
Balance sheet as at 11/01/20x3
40,000 Capital 90,000
Stock 8,000
Debtor 5,000 Liability
Cash at bank 50,000 Creditor 13,000
103,000 103,000
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5.) Sale of a Current Asset on Cash Terms
14/01/20x3; XYZ made cash sales costing Ksh 7,000 to KK enterprises
Balance sheet as at 14/01/20x3
40,000 Capital 90,000
Stock 1,000
Debtor 5,000 Liability
Cash at bank 57,000 Creditor 13,000
103,000 103,000
6.) Payment of a liability
16/01/20x3; XYZ paid Ksh 11,000 for the goods bought on credit.
Balance sheet as at 16/01/20x3
40,000 Capital 90,000
Stock 1,000
Debtor 5,000 Liability
Cash at bank 46,000 Creditor 2,000
92,000 92,000
7.) Collection of a current asset
30/01/20x3; ABC enterprises paid XYZ traders Ksh 3,500 being part settlement of the account.
Balance sheet as at 30/01/20x3
40,000 Capital 90,000
Stock 1,000
Debtor 1,500 Liability
Cash at bank 49,500 Creditor 2,000
92,000 92,000
Illustration 3.1
The following information relates to Alpha traders as at 31
December 20x3. You are required to
prepare a balance sheet as at that date.
Land & Buildings 450,000
Furniture & Fittings 75,500
Motor Vehicles 95,800
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Stocks 57,000
Debtor 17,600
Cash a bank 21,500
Cash in hand 9,000
Creditors 97,700
Capital 224,200
Loan 400,000
Alpha Traders
Balance Sheet as at 31 December 20x3
Non Current Assets Ksh Capital & Liabilities
Land & Buildings 450,000 Capital 224,200
Furniture & Fittings 75,500
Motor Vehicles 95,800 Long term Liability
621,300 Loan 400,000
Current Assets
Stock 57,000 Current Liability
Debtors 17,600 Creditors 97,700
Cash at bank 21,500 Accrued Electricity bill 4,500
Cash in hand 9,000
726,400 726,400
Illustration 3.2
The following assets and liabilities are owned by Jacob a sole trader as at 01/01/20x3.
Accounts payable 56,500
Machinery 150,000
Motor Vehicle 260,600
Stock 105,000
Accounts receivable 155,700
Bank 90,000
Cash 34,000
The following transactions were also captured during the financial period that ended 31/12/20x3.
a) A new machine was purchased on credit worth Ksh 21,500.
b) Additional stock for Ksh 64,000 was purchased via bank.
c) Creditors were partly settled by payment of Ksh 20,000 by cheque.
d) The current debtors paid their account by Ksh 72,000 on cash.
e) Jacob deposited Ksh 5,000 into the bank account as capital.
i. Determine the capital amount for the business at the beginning of the financial period.
ii. Extract a trial balance that captures all the transactions reported.
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i. Capital can be derived using the accounting equation.
Accounts receivable 155,700 Accounts payable 56,500
Machinery 150,000
Motor Vehicle 260,600
Stock 105,000
Bank 90,000
Cash 34,000
Capital = Assets – Liabilities
Capital = 795,300 – 56,500 = Ksh 738,800
ii. To Extract a balance sheet we need to consider the reported transactions
Credit purchase of new machine will Increase both machinery and accounts payable by
Ksh 21,500
Purchase of stock via bank will Increase stock and Reduce bank by Ksh 64,000.
Payment of Creditors by cheque will Reduce accounts payable and bank by Ksh 20,000.
Debtors cash payment will Reduce accounts receivable and Increase cash by Ksh 72,000.
Bank deposit of Ksh 5,000 (as capital) by Jacob will Increase both capital and bank.
This can be summarized as follows:
Assets Ksh Capital & Liabilities Ksh
Accounts receivable 155,700 72,000 Capital 738,800 + 5,000
Machinery 150,000 + 21,500 Liabilities
Motor Vehicle 260,600 Accounts payable 56,500 + 21,500 – 20,000
Stock 105,000 + 64,000
Bank 90,000 – 64,000 – 20,000 + 5,000
Cash 34,000 + 72,000
With the above adjustments prepare final balance sheet:
The Double Entry System
Accounting equation forms the basis of the double entry system. Change in a business involving
Assets, Liabilities or Capital MUST have an effect that is interrelated to the three components of
the accounting equation. This is known as a double effect such that assets will always be equal to
liabilities plus capital. For Example if the owners of a business enterprise put in additional
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capital into the business via bank, this will increase the cash at bank and the capital amount will
also increase hence the equation is still maintained.
According to the accounting equation if all assets are represented by liabilities and capital then
all debit entries should be the same as credit entries.
The Debit and Credit Entries
The Debit Entry is shown on the left hand side of an account (Commonly referred to as a T
Account) while the Credit Entry is shown on the right hand side of an account (Commonly
referred to as a T – Account). Assets are recorded on the debit side while all the liabilities and
capital are recorded on the credit side.
Assets and Liabilities are classified into various categories as covered in lesson two and every
type of asset or liability must have its own account whereby all transactions affecting them are
recorded in that particular account.
This means that there should be individual accounts for Buildings, Equipment, Machinery,
Motor vehicles, Furniture & fittings, Debtors, Creditors, etc. For the double entry to be reflected
in the accounts, every debit entry must have a corresponding credit entry or a set of credit entries
and vice versa. The transactions affecting these accounts are posted in the account as debit entry
and credit entry to complete the double entry.
The following is a layout of accounts with a debit and credit side:
Title of Account
Left-hand side Right-hand side
This side represents the debit’ side This side represents the credit’ side.
These accounts are commonly referred to as T Accounts because the lines separating the two
sides form a ‘ T’ . This is simply illustrated as:
Dr. Title of Account Cr.
Double Entry System for the Various Elements of Financial Statements
As covered in lesson two, we now have an idea of elements used in financial statements.
Remember we have elements for the income statement as well as those for the balance sheet. The
double entry system that is based on the Accounting Equation has interconnectivity with the
discussed elements of financial statements.
Accounting for Assets, Liabilities and Capital.
Assets, Liabilities and Capital comprise of the elements in the Balance Sheet. Activity 3.1,
illustrations 3.1 and 3.2 have been revolving with these elements. The following summary
indicates the double entries relevant to account for them.
Increase in ASSET = DEBIT entry
Decrease in ASSET = CREDIT entry
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Increase in LIABILITY = CREDIT entry
Decrease in LIABILITY = DEBIT entry
Increase in CAPITAL = CREDIT entry
Decrease in CAPITAL = DEBIT entry
Summary table for Balance Sheet Elements
Illustration 3.3
Prepare Asset, Liability and Capital Accounts for Michael who had the following transactions for
the month of January, 20x3.
01/01/20x3: Started business by depositing Ksh 500,000 in the bank.
02/01/20x3: Purchased a Motor Vehicle paying by cheque Ksh 120,000.
05/01/20x3: Purchased Fixtures & Fittings Ksh 40,000 on credit from ABC Ltd.
08/01/20x3: Purchased another Motor Vehicle on credit from XYZ Ltd for Ksh 80,000.
12/01/20x3: Withdrew Ksh 10,000 from the bank and put it into the cash till.
15/01/20x3: Purchased extra Fixtures & Fittings paying by cash Ksh 6,000.
19/01/20x3: Paid XYZ Ltd by cheque Ksh 80,000.
21/01/20x3: Received a loan of Ksh 100,000 in cash from KK financers.
25/01/20x3: Deposited cash amount of Ksh 80,000 into the bank account.
30/01/20x3: Purchased more Fixtures & Fittings by cheque worth Ksh 30,000.
Capital A/c Bank A/c
20x3 Sh. 20x3 Sh. 20x3 Sh. 20x3 Sh.
30/1 Bal c/f 500,000 1/1 Bank 500,000 1/1 Capital 500,000 2/1 M/v 120,000
25/1 Cash 80,000 12/1 Cash 10,000
19/1 XYZ Ltd 80,000
500,000 500,000 30/1 Fixtures 30,000
30/1Bal c/f 340,000
580,000 580,000
Motor Vehicle A/c
20x3 Sh.
20x3 Sh.
2/1 Bank 120,000
8/1 XYZ Ltd 80,000
30/1 Bal c/f 200,000
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Fixtures & Fittings A/c
20x3 Sh.
20x3 Sh.
5/1 ABC Ltd 40,000
15/1 Cash 6,000
30/1 Bank 30,000
30/1 Bal c/f 76,000
XYZ Ltd A/c – Creditors
20x3 Sh.
20x3 Sh.
19/1 Bank 80,000
8/1 M/vehicle 80,000
ABC Ltd A/c – Creditor
20x3 Sh.
20x3 Sh.
30/1 Bal c\f 40,000
8/1 Fixtures & Fittings 40,000
Cash A/c
20x3 Sh.
20x3 Sh.
12/1 Bank 10,000
15/1 Fixtures 6,000
25/1 Bank 80,000
21/1 KK Financers 100,000
30/1 Bal c/f 24,000
KK Financers A/c
20x3 Sh.
20x3 Sh.
30/1 Bal c\f 100,000
21/1 Cash 100,000
Points to Note:
The difference between the debit and credit side is the balancing figure shown in the
form of Bal c/f’ meaning balance carried forward as at the end of that financial period.
Most Assets have a balance on the credit side while most Liabilities and capital accounts
will have a balance on the debit side. This is not always the case because for example a
bank account (asset account) can have a balance on the debit side meaning its
overdrawn that is it has a bank overdraft hence converting the account into becoming a
Prepare a balance sheet from the above accounts
Accounting for Sales, Purchases, Incomes and Expenses
The above comprise the Income statement elements. Sale and purchases might appear to be new
but Sales form part of Revenue while purchases indicate increase in stock or inventory for a
particular business. These elements will be later discussed into details.
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Double Entry System for Elements in the Income Statement
Increase in EXPENSES = DEBIT entry
Decrease in EXPENSES = CREDIT entry
Increase in INCOME/ REVENUE = CREDIT entry
Decrease in INCOME/ REVENUE = DEBIT entry
Summary table Income Statement Elements
Summary table all elements
Accounting for Sales:
Sales are realized after selling goods that were initially bought or purchased by a business with
the purpose of resale. Sales generate revenue for a particular business and can be sub-divided
into either Cash Sales or Credit Sales.
Accounting Treatment for Cash Sales
Debit : Cash/ Bank Account
Credit : Sales Account
Accounting Treatment for Cash Sales
Debit : Debtors Account/ Accounts receivable Account
Credit : Sales Account
Accounting for Purchases:
Purchases involve buying of goods meant for resale by a business firm. Purchases can also be
sub-divided into either for Cash Purchases or Credit Purchases.
Accounting Treatment for Cash Purchases
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Debit : Purchases Account
Credit : Cash/ Bank Account
Accounting Treatment for Credit Purchases
Debit : Purchases Account
Credit : Creditors Account/ Accounts Payable Account
Accounting for Income:
A business firm may generate other income apart from that generated from trading (sales).
These other incomes can include e.g. Rent, Bank interest received, Discounts received etc.
Accounting Treatment for Income received
Debit : Cash/ Bank Account or Account receivable
Credit : Income Account
Each Income should have an individual account.
Incomes increase the capital of a business thus this being the reason as to why they are
posted on the credit side of their respective accounts.
Accounting for Expenses:
Expenses involve amounts incurred in furtherance of generating revenue for a business.
Expenses are paid out for services rendered other than those paid for purchases. Expenses may
include; Electricity bill, Salaries and wages, Bank charges, Motor vehicle expenses, Rent and
rates, Telephone bills, Advertising etc.
Accounting Treatment for Expenses
Debit : Expenses Account
Credit : Cash/ Bank Account or Account Payable
Each expense should have an individual account.
Expenses decrease the capital of a business thus this being the reason as to why they
are posted on the debit side of their respective accounts.
The Asset of Stock (Inventory)
A Stock Account is NEVER maintained because sales are not priced at cost hence sales figures
include elements of profit and loss, and do not represent cost of stock of goods. Stock is
therefore subdivided into several accounts each showing the movement of stock.
Accounts to record increase of stock
Accounts that record any increase in stock are:
Purchases Account
Return Inwards Account
Purchases Account
Records purchases of additional goods either on credit or cash as discussed earlier.
Returns Inwards Account (Sales Returns Account)
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Records return of goods previously sold by a business its customers or debtors. Goods may be
returned for various reasons like being; faulty, wrong type of goods or oversupply.
Return inwards may relate to cash sales or credit sales. Goods returned in relation to a cash sale
that was initially made, cash is refunded to the customer.
Return inwards in relation to a credit sale that was initially made, cash is not refunded <