Features of the VAT system VAT introduction Value-added tax (VAT) is the sales tax used in the UK.

. This means that whenever we buy something from a high street shop, part of the selling price is likely to include an amount that will not contribute to the firm's profits but will be passed on to the government as tax revenue. VAT is administered and collected by the HM Customs and Excise (a department of the UK government). Although some goods and services and small traders are exempt from VAT, most are taxed at a standard rate, which is 17.5%. A firm with a taxable turnover of more than a certain set amount is obliged to be registered for VAT and to make payments to the Customs and Excise department on a regular basis. VAT is collected by all firms involved in the production of a good or service who then sell this on to another consumer (with a turnover of over 80,000 per year). It is possible that the consumer is actually another firm that wants to add something more to the product before selling it on to yet another consumer. For example, a manufacturer of microchips will add VAT on to the selling price of the microchips before selling them on to a computer manufacturer who will, in turn, add VAT on to the selling price of computers. Each firm adds this VAT onto the price it charges to consumers. However, because firms are dealing with other firms in the buying and selling of inputs (materials and products to be sued in the production process) which are subject to VAT, the firms are allowed to 'claim' back VAT paid when purchasing inputs. Rather than having to collect VAT on any sales and also pay VAT on any purchases, firms can use the amount paid on purchases to offset (or reduce) the amount paid on any sales made. The final consumer of the product has no one to sell the product on to the final consumer will pay the full 17.5% VAT. If you are given the net total for any invoice then the VAT on that invoice can be calculated by multiplying it by the following: VAT on invoice = 0.175 x Net invoice total Gross total for invoice = 1.175 x Net invoice total The gross total will include the original net invoice amount plus the VAT due on that invoice.

VAT and discounts

Trade discounts do not appear in any of the ledger accounts and will only appear on the original invoices therefore trade discounts must always be first deducted before calculating the VAT total However, adjustments must be made for cash discounts. The VAT will always be calculated on the net invoice total assuming that the cash discount will be obtained. Even if the payment for the invoice is too late to qualify for the cash discount, the VAT will always be calculated on the assumption that the cash discount is taken.

Calculating Value Added Tax

If the firm sells or purchases goods for cash (i.e. for immediate payment) then VAT will still need calculating. However, this will not be recorded in anything other than the cashbook and the VAT account. On some occasions it is possible that the amount of VAT would have already been included and therefore the VAT will have to be calculated. If an invoice is quoted at the gross amount (already calculated with VAT added on) then we will need to separate the amounts to calculate the net amount for the invoice and the actual VAT total. To find out how much VAT was added on (and therefore how much the original invoice was) we can use the following formula: VAT total = (17.5/117.5) x Gross amount (Alternately, the formula can be reduced down to 7/47 instead but this makes no difference) All that remains is for us to consider the double entry adjustments needed to record transactions containing VAT.

VAT and the double entry system

VAT and the double entry system So far, all our double entry transactions have assumed that there is no VAT to be accounted for. However, we now need to adjust our adjustments to take VAT into account. When we buy or sell goods we know part of the selling price will include VAT (assuming that the firm is registered for VAT). This amount will need to be separated out from the actual net invoice total on both purchases and sales totals

Example 1
On May 8 2000, we sell goods on credit to A Westwood for 200, with VAT on this sale at 35. The total invoice for the sale will be 235. The entry in the sales daybook would appear as follows:

Sales daybook 2000 May 8 A Westwood Net 200 VAT 35 Gross 235

Notice how the net and gross totals for the invoice (with and without VAT) are listed separately. This is important, as we will need both totals to make entries in the ledger accounts.

Example 2
Following on with the same example, on May 15 2000 we purchase 100 of goods from C Stringer. The VAT on this purchase would be 17.50. The entry in the purchases daybook would appear as follows:

Purchases daybook 2000 Net VAT Gross

May 15

C Stringer

100

17.50

117.50

The general rules for entries for VAT on sales and purchases can be formulated form the above two examples. These will be as follows:

VAT on sales Debit Credit Sales Personal account with and VAT account with amount due net invoice account total

with gross invoice total

VAT on purchases Debit Purchases with and VAT account with amount due net invoice account total Personal account Credit

with gross invoice total

VAT and returns

When dealing with returns, both inwards and outwards, then we cannot subject these to our VAT calculations. It would be unfair to have to VAT on goods sold that we actually returned to us by customers. Similarly, we cannot reclaim VAT on goods purchased that we end up returning to the original supplier. If these examples were the only relevant transactions that had taken place during the

month then we could balance off the VAT account at the end of the month to see how much VAT was due. This is done below:

VAT Purchases daybook Returns inwards daybook Balance c/d 35.00 3.50 38.50 12.25

17.50 Sales daybook 8.75 Returns outwards daybook

12.25 38.50 Balance b/d

The credit balance indicates that the firm is liable for VAT of the amount 12.25. This is normally settled by a bank or cash payment. If the balance had been a debit balance then the firm could claim for a refund. However, because this is not normal, it is more likely that the firm would simply wait until the balance had 'slipped back' into credit. VAT is not an expense. It is simply a tax payable. The double entry needed to clear the amount owing would be from either cash account or bank account. In our example this would look as follows:

VAT Cashbook 12.25 Balance b/d 12.25

Cashbook

VAT

12.25

This gives us a simple way of memorising whether or not we owe VAT or are owed VAT. A credit entry in the cashbook implies a payment had been made. Therefore the debit entry in the VAT account from the cashbook must be there to clear the amount owing. Until the amount has been paid, the VAT due should also appear as a current liability on the balance sheet (or as a current asset if it is a debit balance).

VAT and fixed assets

VAT is payable on expenditure relating to fixed assets purchases as well as other expenses related to the running of the business. Some firms will be able to reclaim the VAT paid on fixed asset purchases by offsetting it against the VAT payable on sales, in the same way that VAT paid on purchases is used. For example, if a firm buys a machine for 5,000 and the VAT included amounted to 800, then the firm would only enter the net value of the machine in the assets account (i.e. Debit machinery 4,200) and the VAT would be entered in the account (Debit VAT 800). If a firm cannot reclaim VAT on these items that the full value of the purchase will be entered into the asset account.

Example
Construct VAT account from the following information: 1. 2. 3. 4. Sales for the month were 1,976 which included VAT of 350. Purchases for the month were 1,666 that included VAT of 250. Returns inwards for the month were 800 including VAT of 140. Returns outwards for the month were 588 including VAT of 200.

Example
Construct extracts from the sales, purchases and both returns journals for the month of May 2001 and transfer the totals for the month to the VAT Account. In each case VAT will need adding to the appropriate transaction and is set at 17.5%. 2001 May 1 May 8 May 12 May 14 May 15 May 21 May 27 May 28 May 30 Bought goods on credit: 700 from G Sibon, 500 from P Evans. Sold goods on credit from S Donnelly worth 700. Sent goods back to Sibon worth 450. Sold goods on credit to S Haslem worth 300. Goods returned to us by S Donnelly worth 200. Purchased goods on credit from P Evans worth 850 Goods retuned to us by Haslem worth 100. Sold goods to A Quinn worth 800. Goods returned by us to Evans worth 50.