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.
- Double entry bookkeeping
- Daybooks and ledgers
- Cashbooks and petty cashbooks
- The sales daybook
- Purchases daybook
- Returns daybooks
- The Journal
- Trading and profit and loss accounts
- Balance sheets
- Features of the VAT system
- VAT and the double entry system
- The trial balance
- Bank reconciliation statements
- Control accounts
- Suspense accounts and the correction of errors
- Computers in accounting
These notes are aimed at people studying for AQA A Level Accounting Unit 1, but will also be suitable for other courses and exam boards.
Originally submitted by duke_stix on TSR Forums.