Sales tax (VAT) in prime entries - Output and input tax post...

Learning Outcomes

After reading this article, you will be able to record sales tax (VAT) in the books of prime entry, distinguish between output and input tax, and post the correct double entries to general ledger accounts. You will also interpret how sales tax affects both revenue and purchases, ensuring compliance with ACCA FA2 requirements.

ACCA Maintaining Financial Records (FA2) Syllabus

For ACCA Maintaining Financial Records (FA2), you are required to understand the correct procedures for recording sales tax in prime books and related ledgers. In particular, review these areas as you study this article:

• Recording transactions involving sales tax in the books of prime entry
• Distinguishing between output tax (charged on sales) and input tax (incurred on purchases)
• Posting double entries for sales tax in general ledger accounts
• Presenting sales tax amounts in the financial statements
• Calculating the net amount payable or receivable to tax authorities

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. When a business records a credit sale of $1,000 plus 20% VAT, which accounts are credited and debited in the general ledger?
2. Which account in the general ledger is used to record sales tax on purchases for a VAT-registered business?
3. True or false? Output tax is paid to suppliers, and input tax is collected from customers.
4. Briefly explain what happens to the balance on the sales tax control account at the end of a reporting period.

Introduction

Sales tax (commonly referred to as VAT) is an essential part of bookkeeping for most businesses. It affects both sales and purchase transactions and must be accurately recorded in the books of prime entry and the general ledger. Proper treatment of output and input tax ensures compliance with tax authorities and provides reliable information for preparing financial statements.

Key Term: sales tax
Indirect tax charged on the sale of goods and services, commonly known as VAT. The percentage and treatment may vary by jurisdiction.

Key Term: output tax
Sales tax collected by a business when it sells goods or services, which must be paid to the tax authority.

Key Term: input tax
Sales tax paid by a business on goods or services purchased, which can usually be reclaimed from the tax authority.

SALES TAX IN BOOKS OF PRIME ENTRY

All VAT-registered businesses must record sales tax on both sales and purchases. This section explains how output and input tax are posted in the accounting system.

Taxable Supplies and Registration

Most businesses must register for sales tax once sales reach a specific threshold. Registered businesses account for:

• Output tax: charged on sales
• Input tax: paid on purchases, expenses, and most non-current assets

Sales tax is generally recorded at each transaction, not when cash is received or paid.

Recording Output Tax on Sales

When goods or services are sold, output tax is added to the net selling price. The gross amount (net amount + VAT) is charged to the customer.

Double Entry for a Credit Sale

Suppose a business sells goods on credit for $2,000, VAT at 20%.

• Net sale: $2,000
• VAT (20%): $400
• Gross invoice: $2,400

The sales tax and revenue must be split for correct accounting.

Key Term: sales tax payable
The liability account representing the amount of output tax owed to the tax authority.

Recording Input Tax on Purchases

When the business buys goods or services, input tax is included in purchase invoices. For VAT-registered entities, this input tax can usually be reclaimed.

Double Entry for a Credit Purchase

A purchase is made for $1,000 plus VAT at 20% ($200), total $1,200:

Key Term: sales tax recoverable
The asset account showing input tax amounts to be reclaimed from the tax authority.

The Sales Tax Control Account

All output and input tax for the period are posted to the sales tax control account.

At the end of each period:

• If output tax > input tax: the difference is owed to tax authority.
• If input tax > output tax: the business is due a refund.

The control account is cleared when payment is made or a refund received.

Worked Example 1.1

A business makes the following transactions in one month:

• Credit sales (net): $10,000, VAT 20%
• Credit purchases (net): $4,000, VAT 20%
• All amounts unpaid at month end

Question:
Post the sales, purchases, and sales tax double entries for the month, and show the closing balance on the sales tax control account.

Answer:
Sales:

• Debit Receivables $12,000 (10,000 + 2,000 VAT)
• Credit Sales $10,000
• Credit Sales tax payable $2,000
  Purchases:
• Debit Purchases $4,000
• Debit Sales tax recoverable $800 (4,000 × 20%)
• Credit Payables $4,800
  Closing balance on sales tax control account:
  Output tax: $2,000
  Less input tax: $800
  Net payable to authority: $1,200 (credit balance in sales tax control account)

Exam Warning

Always split sales and purchases from their VAT components. Do not post the full gross value to one account. This is a common ACCA exam error.

Displaying Sales Tax in the Financial Statements

• Receivables and payables are shown inclusive of sales tax.
• Revenue and expense items in the profit or loss statement are recorded exclusive of sales tax.
• The sales tax control/ledger account appears as a current liability or, less commonly, a current asset.

Worked Example 1.2

A business buys equipment for $6,000 plus VAT at 20% ($1,200) on credit, and sells goods for $3,000 plus VAT at 20% ($600) on credit.

Question:
How are these entries posted for both transactions, and what is the effect on the sales tax control account?

Answer:
Purchases:

• Debit Non-current assets $6,000
• Debit Sales tax recoverable $1,200
• Credit Payables $7,200
  Sales:
• Debit Receivables $3,600
• Credit Sales $3,000
• Credit Sales tax payable $600
  Sales tax control account balance:
  Output tax ($600) - Input tax ($1,200) = $600 receivable from tax authority (debit in sales tax control account).

Calculating Sales Tax from Gross and Net Values

• To find VAT from a net figure: VAT = Net × Rate
• To extract VAT from a gross figure: VAT = Gross × [Rate/(100% + Rate%)]

Example:

• Net: $500, VAT 20% → VAT = $100, Gross = $600
• Gross: $600, VAT 20% → VAT = $600 × 20/120 = $100

Revision Tip

Practice extracting VAT from both net and gross figures, as this skill is frequently tested.

Summary

Correct recording of sales tax in prime entries is essential for accurate ledgers and compliance. Keep sales and purchases net of VAT in income and expense accounts, with output and input VAT posted to the sales tax control account. The net balance represents the tax payable or receivable at period end.

Key Point Checklist

This article has covered the following key knowledge points:

• Recording and posting output and input tax in the books of prime entry and ledgers
• Distinguishing between sales tax on sales (output tax) and purchases (input tax)
• Calculating VAT from both net and gross amounts
• Balancing the sales tax control account and preparing for settlement with tax authorities
• Showing VAT amounts correctly in financial statements

Key Terms and Concepts

• sales tax
• output tax
• input tax
• sales tax payable
• sales tax recoverable