Learning Outcomes
After reading this article, you will be able to account for sales tax (VAT) in books of prime entry, including recognizing and recording input and output tax, preparing and adjusting sales tax returns, and dealing with errors or amendments. You will be able to explain how VAT affects sales, purchases, and prime entries, and how to make accurate adjustments for underpayments or overpayments relevant to exam questions.
ACCA Maintaining Financial Records (FA2) Syllabus
For ACCA Maintaining Financial Records (FA2), you are required to understand how sales tax (VAT) is recorded, reported, and adjusted in the accounting system. Focus your revision on the following areas:
- The principles of recording VAT (sales tax) on sales and purchases in the books of prime entry and ledgers
- The distinction between input and output tax for VAT-registered entities
- The correct completion and reconciliation of VAT returns, including dealing with errors and adjustments
- The process for making VAT adjustments in the accounting records following discovery of errors or receipt of new information
- Understanding documentation requirements and statutory deadlines for tax reporting
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.
-
What is the correct double-entry to record a credit sale including VAT at 20% if the net sales value is $2,000?
- a) Dr Receivables $2,000; Cr Sales $2,000
- b) Dr Receivables $2,400; Cr Sales $2,000; Cr Sales tax liability $400
- c) Dr Cash $2,000; Cr Sales $2,000
- d) Dr Receivables $2,000; Cr Sales $1,600; Cr Sales tax liability $400
-
True or false? If a business finds that it has under-reported output tax in a previous return, the adjustment must be recorded in both the VAT return and the accounting records.
-
A purchase invoice is received for $1,200 including VAT (20%). What will be the correct entries in the purchase and VAT ledger accounts?
-
Explain briefly why it is important for a business to perform reconciliations before submitting its sales tax return.
Introduction
Sales tax, often referred to as VAT (Value Added Tax), is a government levy applied to most goods and services. For accounting purposes, it affects how transactions are recorded at the point of initial entry (books of prime entry), as well as how businesses complete tax returns and make any necessary adjustments. Failure to account for VAT correctly can result in errors, penalties, and misstated profits.
This article guides you through the correct treatment of VAT in the prime entries, explains the process of completing sales tax returns, and details how to handle necessary adjustments when discrepancies or omissions are found.
Key Term: sales tax (VAT)
An indirect tax charged on most sales of goods and services, collected by registered businesses on behalf of the tax authorities.Key Term: input tax
The VAT included in the price of goods and services purchased by a business, which can be reclaimed from the tax authorities by VAT-registered entities.Key Term: output tax
The VAT a business adds to the price of its sales and is required to pay over to the tax authorities.
Sales Tax in Prime Entries
Sales tax must be accounted for every time a sale or purchase is entered in the accounting records. The correct recording ensures compliance and provides the basis for preparing periodic returns.
Recording Output Tax on Sales
When a VAT-registered entity sells taxable goods or services, it must add VAT (output tax) to the sales price. Both the net sale and the VAT element must be recorded in the books of prime entry.
Example: Net sales value = $1,500; VAT rate = 20%; Gross invoice = $1,800. The entries are:
- Debit Receivables (or Cash): $1,800
- Credit Sales: $1,500
- Credit Sales tax liability: $300
Output tax entries are cumulative for the period and form part of the overall VAT liability.
Recording Input Tax on Purchases
When purchasing goods and services for business use, VAT-registered entities pay VAT (input tax) to their suppliers. This input tax can generally be reclaimed.
Example: Net purchase = $600; VAT = 20% ($120); Gross payment = $720.
- Debit Purchases (expense/asset): $600
- Debit Sales tax recoverable: $120
- Credit Payables (or Cash): $720
Only the net amount is treated as an expense—input tax is a recoverable asset or reduces the tax to be paid.
Key Term: sales tax return
A periodic statement filed by a business, showing total output tax on sales, input tax on purchases, and the net tax to pay or reclaim.
Completing Sales Tax Returns
VAT-registered entities must submit regular sales tax returns (often quarterly) to the tax authority. The return reports output tax collected, input tax suffered, and calculates the net amount payable or reclaimable.
Key components of a typical return include:
- Total value of taxable sales and related output tax
- Total value of taxable purchases and related input tax
- Adjustments for errors or corrections from prior periods
- Net amount payable or reclaimable
The figures in the return should agree with the balances in the accounting records.
Worked Example 1.1
A company has, for the quarter, output tax of $15,200 and input tax of $10,800. What amount will be paid, and what double-entry is needed?
Answer:
The net amount to pay is $4,400 ($15,200 output tax – $10,800 input tax).
Double entry to clear the period:
- Debit Sales tax payable (liability): $4,400
- Credit Cash at bank: $4,400
Adjustments and Corrections for Tax
Occasionally, errors are found after entries have been made or a return has been filed. Adjustments are needed to ensure records remain correct and the correct amount is paid or reclaimed.
Common Adjustments
- Omissions: Purchases or sales not previously recorded.
- Misstatements: Sales or purchases recorded with wrong VAT calculations.
- Receipts/Payments after the period: Credit notes or late invoices affecting previous returns.
How to Adjust the Accounting Records
Once an error is discovered, the accounting records—and potentially the VAT return—must be corrected. The adjustment should be posted as soon as possible and referenced properly.
For an omitted sales invoice (net $2,000, VAT at 20%):
- Debit Receivables: $2,400
- Credit Sales: $2,000
- Credit Sales tax liability: $400
For an overstated input tax adjustment in a previous period:
- Debit Sales tax recoverable: $X (reduce input claim)
- Credit Expense or Purchases: $X
Key Term: sales tax control account
The general ledger account that accumulates all input and output VAT entries, showing the net liability or asset at reporting dates.
Documentation and Reporting Requirements
Proper supporting documents must be kept for all amounts declared on the VAT return, including:
- All sales and purchase invoices
- Credit notes and debit notes
- Evidence of VAT rate applied (standard, reduced, zero, exempt)
- Correspondence relating to adjustments or errors
Failure to retain supporting documentation can result in penalties or disallowed claims.
Worked Example 1.2
After submitting its VAT return, Firm Q discovers a purchase invoice for net $1,000 (VAT $200) was omitted. The error is found before the next return is filed.
Question: How should Firm Q amend its accounting records and the upcoming return?
Answer:
- Record the purchase with proper input tax:
- Debit Purchases: $1,000
- Debit Sales tax recoverable: $200
- Credit Payables: $1,200
- Include the omitted input tax on the next period's sales tax return, referencing the adjustment as required by the tax authority.
Exam Warning
Always ensure adjustments are reflected in both the sales tax control account and the correct subsequent return. Reporting corrections in the wrong period can result in exam penalties for poor application.
Summary
VAT impacts all stages of recording, returns, and adjustments. The correct treatment of input and output tax in prime entries is essential for accurate results and compliance. Regular reconciliations, timely adjustments, and complete documentation are critical for completing returns error-free and avoiding penalties.
Key Point Checklist
This article has covered the following key knowledge points:
- Record sales and purchases with correct VAT in the books of prime entry
- Distinguish between input and output tax, and know how each affects accounts
- Complete VAT returns, show correct calculations for amounts payable/recoverable
- Post adjustments for errors or late invoices in accounting records and subsequent returns
- Know documentation and reporting requirements for supporting VAT returns
Key Terms and Concepts
- sales tax (VAT)
- input tax
- output tax
- sales tax return
- sales tax control account