Diegetic Sound –
Diegetic Sound is audio which is visible on the screen or is implied to be present by the action of a character. In terms of games design these audio clips will be sounds such as the voice of the character or the noises that have been made by an object that has been interacted with. Diegetic sound can be on screen or off screen, it depends on the source of the audio, if it is present within the environment then it is Diegetic.
Non-Diegetic Sound –
This is audio where the source is neither visible on screen or implied to be present within the scene. Within a games design non-diegetic sounds will be used just as much as diegetic sounds. An example of a non-diegetic sounds that may be used is a narrator talking or the music that is used to set the mood. This audio may be present within the game however there is no source within the environment or scene.
Example Comparison –
An example is that Scary Ambient music may be used to set the overall mood in a horror game but the music is just played in the background and does not come from a source within the scene (this is non-diegetic), however the footsteps that are used will be diegetic as the player knows that the source is the players feet connecting the the ground.
Source – http://filmsound.org/terminology/diegetic.htm