## **Learning Outcomes**

After reading this article, you will be able to calculate VAT on sales and purchase invoices, including when a trade discount applies. You will be able to enter the net amount, VAT and gross total into the correct day book and post day book totals to the general ledger. You will also be able to explain and record settlement discounts at the payment stage, and apply the correct VAT treatment for credit notes and returns.

## **ACCA Recording Financial Transactions (FA1) Syllabus**

For ACCA Recording Financial Transactions (FA1), you must understand...

- how to record sales and purchases taking into account discounts and VAT
- the difference between trade discounts and settlement discounts, and the VAT impact
- how invoices and credit notes are entered into the accounting system
- how books of prime entry (day books) feed into double-entry bookkeeping
- how input tax and output tax affect the VAT ledger (VAT control) account

## **Test Your Knowledge**

_Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision._

1. A sales invoice is for £800 less 10% trade discount, plus VAT at 20%. What VAT is recorded in the sales day book?
   - A. £160
   - B. £144
   - C. £128
   - D. £72

2. True or false? A settlement discount reduces the VAT posted to the VAT control account.

3. Which day book would you use to record a credit note received from a supplier for goods returned?
   - A. Sales day book
   - B. Sales returns day book
   - C. Purchases returns day book
   - D. Purchases day book

4. State the three ledger postings made from the total of the sales day book (assume VAT is charged on sales).

5. True or false? A trade discount is recorded in a “discount allowed/received” ledger account at the invoice date.

## **Introduction**

VAT questions in FA1 often look simple, but marks are lost when the wrong figure is used as the VAT base. The most common cause is mixing up trade discounts (price reductions at invoice date) with settlement discounts (reductions for paying early).

Day books (books of prime entry) usually have separate columns for net, VAT and total. If you calculate the net amount wrongly, every posting that follows (sales/purchases, receivables/payables, and VAT) will also be wrong. This article shows you the correct approach for invoices, credit notes and discounts.

## VAT basics for FA1

> **Key Term: VAT**
> Value Added Tax (VAT) is a sales tax charged on taxable supplies; a business collects it on sales and pays it on purchases.
>
> **Key Term: Output tax**
> Output tax is VAT charged on sales and collected from customers on behalf of the tax authority.
>
> **Key Term: Input tax**
> Input tax is VAT charged by suppliers on purchases, which the business may be able to reclaim.
>
> **Key Term: VAT control account**
> The VAT control account is the general ledger account used to record input tax (debit) and output tax (credit) and show the net VAT payable/receivable.

### VAT amounts you record

VAT is usually calculated on the net value of the supply (the price before VAT). If the VAT rate is $r\%$, then:

- Net amount $=$ amount before VAT
- VAT amount $=$ net $\times \dfrac{r}{100}$
- Gross total $=$ net $+$ VAT

## Day books and VAT columns

> **Key Term: Day book (book of prime entry)**
> A day book is a listing of similar transactions (for example credit sales) used to collect totals before posting to the general ledger.

Day books commonly used in FA1 include:

- sales day book (credit sales invoices issued)
- purchases day book (credit purchase invoices received)
- sales returns day book (credit notes issued to customers)
- purchases returns day book (credit notes received from suppliers)

In VAT questions, day books often have columns such as _Net_, _VAT_ and _Total_. You record each invoice line using the correct VAT base, then total the columns for posting.

## Trade discounts: VAT is calculated after the trade discount

> **Key Term: Trade discount**
> A trade discount is a reduction in the list price, given at the invoice date (often for bulk buying or being a regular customer).

A trade discount changes the selling price, so it changes the VAT base. In practice, you calculate:

1. list price
2. less trade discount $=$ net price before VAT
3. VAT on the net price
4. total payable

Trade discounts are not recorded in a separate “discount” ledger account at invoice date; you record the invoice at the net amount.

### **Worked Example 1.1**

On 10 March, Nuru Ltd sells goods on credit to Asha Traders. List price £2,000, trade discount 15%, VAT 20%. Show the sales day book entry and the ledger postings from this invoice.

> **Answer:**
>
> $$
> \text{Trade discount} = 2{,}000 \times 15\% = £300
> $$
>
> $$
> \text{Net (VAT base)} = 2{,}000 - 300 = £1{,}700
> $$
>
> $$
> \text{VAT} = 1{,}700 \times 20\% = £340
> $$
>
> $$
> \text{Total owed} = 1{,}700 + 340 = £2{,}040
> $$
>
> **Sales day book (single line):** Net £1,700; VAT £340; Total £2,040
>
> **Postings (from this invoice):**  
> Dr Trade receivables £2,040  
> Cr Sales £1,700  
> Cr VAT control (output tax) £340

## Settlement discounts: VAT is not adjusted

> **Key Term: Settlement discount**
> A settlement discount is a reduction offered for paying an invoice within a specified time period.

Settlement discounts are recorded only when payment happens (because the customer may not pay early). For FA1, the usual rule applied is:

- settlement discount is calculated on the net amount (excluding VAT)
- VAT recorded at invoice date is not reduced when the settlement discount is taken

### **Worked Example 1.2**

Using Worked Example 1.1, Asha Traders pays within the discount period and is allowed 2% settlement discount on the net amount. Show the receipt and the double entry.

> **Answer:**
>
> $$
> \text{Settlement discount} = 1{,}700 \times 2\% = £34
> $$
>
> $$
> \text{Cash received} = 2{,}040 - 34 = £2{,}006
> $$
>
> VAT stays at £340 (no adjustment).
>
> **Double entry (in Nuru Ltd’s books):**  
> Dr Bank £2,006  
> Dr Discount allowed £34  
> Cr Trade receivables £2,040

### **Exam Warning**

A common error is to calculate the settlement discount on the VAT-inclusive total (£2,040). In FA1 questions, settlement discount is normally on the net amount only, and VAT is not changed at payment.

## Credit notes and returns: VAT is reversed with the net amount

> **Key Term: Credit note**
> A credit note is a document that reduces the amount owed, often due to returns, overcharging, or an allowance.

If a customer returns goods, the seller issues a credit note. You reverse both:

- the net sale/purchase value, and
- the VAT charged on that net value.

In day book terms:

- a sales credit note goes into the _sales returns day book_ (reduces receivables, reduces output tax)
- a purchase credit note goes into the _purchases returns day book_ (reduces payables, reduces input tax)

## Posting VAT from day books to the general ledger

### Sales day book (credit sales invoices issued)

When you total the sales day book for a period, the posting is:

- Dr Trade receivables (total gross)
- Cr Sales (total net)
- Cr VAT control (output tax total)

### Purchases day book (credit purchase invoices received)

When you total the purchases day book for a period, the posting is:

- Dr Purchases (total net) _(or the relevant expense account)_
- Dr VAT control (input tax total)
- Cr Trade payables (total gross)

### Returns day books (credit notes)

Totals from returns day books reverse the original entries:

- Sales returns day book total:
  - Dr Sales returns (net)
  - Dr VAT control (output tax reduction)
  - Cr Trade receivables (gross)
- Purchases returns day book total:
  - Cr Purchase returns (net)
  - Cr VAT control (input tax reduction)
  - Dr Trade payables (gross)

## Extracting VAT from a VAT-inclusive amount

Sometimes you are given a gross amount that already includes VAT (for example, a till receipt). If VAT rate is $r\%$:

$$\text{Net} = \text{Gross} \times \frac{100}{100+r}$$

$$\text{VAT} = \text{Gross} - \text{Net}$$

### **Revision Tip**

Before calculating VAT, decide whether the discount is a trade discount (affects the VAT base) or a settlement discount (recorded at payment, VAT usually unchanged in FA1 questions).

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- VAT is recorded as output tax on sales and input tax on purchases, via the VAT control account.
- Day books commonly include net, VAT and total columns, and totals are posted to the ledger.
- Trade discounts reduce the VAT base, so VAT is calculated after the trade discount.
- Settlement discounts are recorded at payment date and normally do not change the VAT already recorded.
- Sales day book totals post: Dr receivables; Cr sales; Cr VAT output.
- Purchases day book totals post: Dr purchases/expenses; Dr VAT input; Cr payables.
- Credit notes reverse both the net amount and the VAT related to that net amount.
- VAT can be extracted from VAT-inclusive figures using $\dfrac{100}{100+r}$.

## **Key Terms and Concepts**

- VAT
- Output tax
- Input tax
- VAT control account
- Day book (book of prime entry)
- Trade discount
- Settlement discount
- Credit note


Recording VAT in day books - Discounts and VAT treatment