## **Learning Outcomes**

After reading this article, you will be able to define VAT, output VAT and input VAT, and explain the difference between taxable, zero-rated and exempt supplies. You will be able to calculate VAT from both net and gross amounts at any rate using a VAT fraction. You will also be able to record VAT on sales and purchases in double-entry, maintain a VAT control account, and determine whether net VAT is payable to, or recoverable from, the tax authority.

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

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

- when a business charges VAT and what “VAT registered” means
- the meaning of taxable supplies and the difference between standard-rated, reduced-rated, zero-rated and exempt supplies
- how to calculate VAT from net and gross figures at different VAT rates
- what output VAT and input VAT are, and how they arise on sales and purchases
- how to record VAT in ledger accounts and keep sales/purchases net of VAT
- how to calculate net VAT payable/receivable for a period and show it in the statement of financial position

## **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. Which statement best describes output VAT?
   - A. VAT charged by suppliers on your purchases
   - B. VAT you charge customers on taxable sales
   - C. VAT included in employee wages
   - D. VAT that can never be reclaimed

2. True or false? A business making only exempt supplies cannot reclaim input VAT on its purchases.

3. A retailer sells goods for £960 including VAT at 20%. Calculate:
   - (i) the VAT element
   - (ii) the net selling price

4. Output VAT for the quarter is £12,400 and input VAT is £9,750. What is the net VAT position?
   - A. Refund due of £2,650
   - B. Payment due of £2,650
   - C. Refund due of £22,150
   - D. Payment due of £22,150

5. State whether trade receivables are recorded net or gross of VAT in the statement of financial position.

## **Introduction**

VAT affects many day-to-day bookkeeping entries, because sales invoices and purchase invoices often include a tax amount that the business collects or pays on behalf of the government.

For FA1, you must be clear about the language used (output VAT, input VAT, taxable, exempt) and how VAT flows through the ledger accounts. Many exam errors come from posting the gross amount to sales or purchases, or using the wrong method to extract VAT from a gross figure.

## VAT basics for bookkeeping

> **Key Term: VAT (Value Added Tax)**
> An indirect tax added to the price of many goods and services, collected by VAT-registered businesses and paid over to the tax authority.
>
> **Key Term: VAT-registered business**
> A business that must charge VAT on taxable sales and can usually reclaim VAT charged by suppliers on business purchases.

A VAT-registered business is a “collector” of VAT: it charges VAT to customers, pays VAT to suppliers, and then settles the difference with the tax authority. In FA1 questions, VAT is normally dealt with through a VAT control account (sometimes called a sales tax account).

## VAT categories: what is taxed (and at what rate)

> **Key Term: Taxable supply**
> A sale of goods or services that is within the VAT system and may be charged at the standard rate, reduced rate or zero rate.
>
> **Key Term: Standard-rated supply**
> A taxable supply charged at the main VAT rate set by the government.
>
> **Key Term: Reduced-rated supply**
> A taxable supply charged at a lower VAT rate that applies to certain specified goods or services.
>
> **Key Term: Zero-rated supply**
> A taxable supply where VAT is charged at 0%, meaning no VAT is added to the selling price but input VAT can still be reclaimed (subject to the rules).
>
> **Key Term: Exempt supply**
> A sale outside VAT charging: no output VAT is charged and input VAT related to exempt activities is not reclaimable.

The key exam point is the difference between **zero-rated** and **exempt**. Zero-rated sales are still taxable sales (rate = 0%), so they can support recovery of input VAT in many questions. Exempt sales do not.

## Output VAT (output tax)

> **Key Term: Output VAT (output tax)**
> VAT charged on a VAT-registered business’s taxable sales and collected from customers for the tax authority.

Output VAT arises when you issue a sales invoice (or make a cash sale) for a taxable supply. If a net price is given, output VAT is calculated as a percentage of the net amount.

For a credit sale, the customer owes the **gross** amount (net + VAT). The sales income recorded in the statement of profit or loss is the **net** amount only.

## Input VAT (input tax)

> **Key Term: Input VAT (input tax)**
> VAT charged by suppliers on a business’s purchases, expenses and non-current assets, which is usually reclaimable by a VAT-registered business.

Input VAT arises when a supplier charges VAT on an invoice/receipt and your business is allowed to reclaim it. In bookkeeping terms, you record the purchase or expense **net**, and record the VAT separately as input VAT.

In many FA1 questions, you can assume input VAT is reclaimable unless you are told the purchases relate to exempt activities or the business is not VAT registered.

## Net VAT and the VAT control account

> **Key Term: VAT control account**
> A ledger account used to collect output VAT (credited) and input VAT (debited) and show the net amount payable to, or recoverable from, the tax authority.
>
> **Key Term: Net VAT**
> The difference between output VAT and input VAT for a VAT period, which results in either a payment due or a refund due.

Net VAT is usually calculated as:
$$\text{Net VAT} = \text{Output VAT} - \text{Input VAT}$$

- If output VAT is higher, net VAT is **payable** (a liability).
- If input VAT is higher, net VAT is **recoverable** (an asset/receivable).

## Calculating VAT from net and gross amounts

> **Key Term: VAT fraction**
> A fraction used to extract VAT from a gross amount:
>
> $$
> \frac{r}{100+r}
> $$
>
> where r is the VAT rate as a percentage.

You need two common methods:

1. **Net to gross** (VAT added on top)
   - VAT $= \text{Net} \times \frac{r}{100}$
   - Gross $= \text{Net} \times \left(1+\frac{r}{100}\right)$

2. **Gross to net** (VAT extracted from an amount that includes VAT)
   - VAT $= \text{Gross} \times \frac{r}{100+r}$
   - Net $= \text{Gross} \times \frac{100}{100+r}$

### **Worked Example 1.1**

A sale is £960 gross, including VAT at 20%. Calculate the VAT element and the net sale.

> **Answer:**
>
> $$
> \text{VAT} = 960 \times \frac{20}{120} = 160
> $$
>
> $$
> \text{Net sale} = 960 - 160 = 800
> $$

### **Exam Warning**

Do not calculate VAT from a gross figure using $\text{Gross} \times r\%$. If the price already includes VAT, you must extract it using the VAT fraction.

## Recording VAT in double-entry (what FA1 expects)

### Credit sale (taxable, VAT registered)

Record the customer’s debt at the gross amount, but keep revenue net:

- Debit Trade receivables (gross)
- Credit Sales (net)
- Credit VAT control account (output VAT)

### Credit purchase (taxable, VAT registered)

Record the supplier’s balance at the gross amount, but keep purchases/expenses net:

- Debit Purchases/expense/non-current asset (net)
- Debit VAT control account (input VAT)
- Credit Trade payables (gross)

### **Worked Example 1.2**

During a quarter, a business has output VAT of £4,600 and input VAT of £3,900. Calculate net VAT and show the entry to pay the tax authority.

> **Answer:**
>
> $$
> \text{Net VAT} = 4{,}600 - 3{,}900 = 700
> $$
>
> payable (liability).  
> Payment entry:
>
> - Debit VAT control account £700
> - Credit Bank £700

### Presentation point often tested

- Trade receivables and trade payables are shown **gross** in the statement of financial position.
- Sales income and expenses in the statement of profit or loss are shown **net** of VAT.
- Only the **net** VAT balance (payable or receivable) remains on the statement of financial position at the end of the VAT period.

### **Revision Tip**

Use the quick “100 / $r$ / $100 + r$” layout to move between net, VAT and gross. For example, at 20%: net 100, VAT 20, gross 120.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- VAT-registered businesses charge VAT on taxable sales and can usually reclaim VAT on business purchases.
- Output VAT is VAT charged to customers on taxable supplies.
- Input VAT is VAT charged by suppliers on purchases, expenses and assets (often reclaimable).
- Zero-rated supplies are taxable at 0%; exempt supplies are outside VAT charging and restrict input VAT recovery.
- Net VAT is calculated as output VAT minus input VAT for the period.
- VAT can be calculated from net values using $r\%$, and extracted from gross values using the VAT fraction $\frac{r}{100+r}$.
- A VAT control account collects output VAT (credit) and input VAT (debit) and shows the net payable/receivable.
- Receivables/payables are recorded gross; income and expenses are recorded net of VAT.

## **Key Terms and Concepts**

- VAT (Value Added Tax)
- VAT-registered business
- Taxable supply
- Standard-rated supply
- Reduced-rated supply
- Zero-rated supply
- Exempt supply
- Output VAT (output tax)
- Input VAT (input tax)
- VAT control account
- Net VAT
- VAT fraction


VAT concepts and terminology - Output tax, input tax, and net VAT