## **Learning Outcomes**

After reading this article, you will be able to distinguish between tax-inclusive and tax-exclusive pricing, calculate and record sales tax (VAT) in transactions, and identify the correct accounting entries in prime books for different pricing methods. You will also be prepared to explain how sales tax affects both sales and purchases in financial records, essential for the ACCA Maintaining Financial Records (FA2) exam.

## **ACCA Maintaining Financial Records (FA2) Syllabus**

For ACCA Maintaining Financial Records (FA2), you are required to understand the principles and process of accounting for sales tax in primary accounting records. This article covers the following syllabus areas:

- Calculate and record sales tax (VAT) on sales and purchases
- Distinguish between tax-inclusive and tax-exclusive prices
- Post transactions to the books of prime entry (sales day book, purchase day book)
- Determine the correct double-entry for VAT in sales and purchase transactions
- Report sales tax in financial statements and understand its treatment as an asset or liability

## **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 business sells goods for \$240, inclusive of 20% sales tax. What is the net (tax-exclusive) sales value?
   a) \$200
   b) \$220
   c) \$192
   d) \$240

2. Which is TRUE when recording a purchase transaction at a tax-exclusive price with VAT at 20%?
   a) Debit Purchases with total paid, credit Cash at bank with net only
   b) Debit Purchases and Sales Tax Recoverable, credit Trade Payables with the gross amount
   c) Credit Purchases, debit Trade Payables, credit Sales Tax Liability
   d) Debit Purchases with gross, credit Bank and ignore VAT

3. True or false? If an invoice is tax-inclusive, the sales tax can be found by dividing the gross amount by 1 plus the tax rate, then multiplying by the rate.

4. Briefly explain how the double-entry for VAT differs between tax-exclusive and tax-inclusive sale transactions.

## **Introduction**

Correctly recording sales tax (VAT) is essential in maintaining financial records. Transactions may be quoted either with tax included (tax-inclusive) or excluded (tax-exclusive), and this affects both calculation and the initial accounting entries. Understanding the difference ensures the prime books – such as sales day and purchase day books – accurately reflect both the transaction value and the VAT component. This article explains how to calculate, split, and post VAT correctly for each pricing method, with worked examples and exam-focused tips.

> **Key Term: sales tax (VAT)**
> An indirect tax charged on the sale of most goods and services, collected by VAT-registered businesses and paid over to the tax authority. Also known as value added tax (VAT) in some countries.

## **TAX-EXCLUSIVE VS TAX-INCLUSIVE PRICING**

Businesses often encounter both tax-exclusive and tax-inclusive prices on sales and purchase documentation. The method used determines the VAT calculation and the figure posted to the ledgers.

### Tax-Exclusive Pricing

A tax-exclusive price shows the value of goods or services before tax. The VAT is calculated and added to this net price. Business-to-business invoices frequently use this approach.

### Tax-Inclusive Pricing

A tax-inclusive price shows the total amount payable, including VAT. This is common in retail or consumer sales, where the customer sees the full price.

> **Key Term: tax-exclusive price**
> A price stated before sales tax has been added. VAT is calculated on this amount and added to determine the gross price.
>
> **Key Term: tax-inclusive price**
> A price stated including sales tax. The VAT element is embedded within the gross figure shown to the customer.

## **CALCULATING SALES TAX IN PRIME RECORDS**

The first step in processing VAT is determining the net and VAT amounts, depending on whether the price is tax-inclusive or tax-exclusive.

### Calculating VAT from Tax-Exclusive Price

If a sales invoice shows a net value and the applicable VAT rate:

- VAT = Net price × VAT rate
- Gross = Net price + VAT

_Example_: Net goods: \$500, VAT @ 20%

- VAT: \$500 × 20% = \$100
- Gross: \$600

### Calculating VAT from Tax-Inclusive Price

If a price includes VAT, extract the VAT as follows:

- VAT = Gross price × (VAT rate ÷ (100% + VAT rate))
- Net = Gross price – VAT

_Example_: Gross price: \$240, VAT @ 20%

- VAT: \$240 × (20 ÷ 120) = \$40
- Net: \$200

### **Worked Example 1.1**

A shop sells an item for \$1,200, price shown includes 20% VAT. What are the amounts for net sales and VAT?

> **Answer:**
>
> - VAT = \$1,200 × (20/120) = \$200
> - Net sales = \$1,200 – \$200 = \$1,000

## **ACCOUNTING FOR VAT IN PRIME ENTRIES**

Recording VAT correctly in the primary accounting books (e.g., sales or purchases day book) depends on the transaction.

### Sales at Tax-Exclusive Price

- Debit: Receivables (gross)
- Credit: Sales (net)
- Credit: VAT liability (VAT)

### Sales at Tax-Inclusive Price

First, extract the net and VAT from the gross total, then post:

- Debit: Receivables (gross)
- Credit: Sales (net)
- Credit: VAT liability (VAT)

### Purchases at Tax-Exclusive Price

- Debit: Purchases or Expense (net)
- Debit: VAT recoverable (VAT)
- Credit: Payables (gross)

### Purchases at Tax-Inclusive Price

Split the gross figure into net and VAT, then post as above.

> **Key Term: VAT liability**
> The total VAT collected on sales, less VAT paid on purchases, due to be paid to the tax authority.
>
> **Key Term: VAT recoverable**
> VAT paid by a business on purchases and expenses, which can usually be reclaimed from the tax authority.

### **Worked Example 1.2**

A VAT-registered business buys equipment for \$720, price includes VAT at 20%. Show the entries in the prime records.

> **Answer:**
>
> - VAT: \$720 × (20/120) = \$120
> - Equipment (debit): \$600
> - VAT recoverable (debit): \$120
> - Payables or Cash at bank (credit): \$720

### Posting to the Sales or Purchases Day Book

For each transaction, ensure that VAT is recorded as a separate column in the prime book:

- Sales day book: Columns for Net Sales, VAT, and Total
- Purchase day book: Columns for Net Purchases, VAT, and Total

### **Worked Example 1.3**

A retailer records a cash sale of \$240 (VAT included, 20%). What appears in each column of the cash sales journal?

> **Answer:**
>
> - Sales (net): \$240 – \$40 = \$200
> - VAT: \$40
> - Total: \$240

### **Exam Warning**

Do not post the total gross amount to both sales/purchases and VAT accounts. Always split VAT from the net value, even for tax-inclusive invoices in the exam. Incorrect splitting may result in misstated sales or purchase figures and VAT balances.

## **Summary**

Sales tax (VAT) treatment in prime entries depends on whether the price is tax-inclusive or tax-exclusive. Always calculate and post VAT and net figures separately. Correct postings are essential for compliance and for preparing accurate financial statements, with VAT classified as a liability (for output VAT on sales) or an asset (for input VAT on purchases) in the accounts.

## **Key Point Checklist**

_This article has covered the following key knowledge points:_

- Distinguish between tax-exclusive and tax-inclusive prices
- Calculate VAT from both net and gross amounts
- Post correct VAT entries in sales and purchase day books
- Record the correct double-entry for both purchases and sales involving VAT
- Present VAT as a separate column and ledger balance in the accounts

## **Key Terms and Concepts**

- sales tax (VAT)
- tax-exclusive price
- tax-inclusive price
- VAT liability
- VAT recoverable

Sales tax (VAT) in prime entries - Tax-inclusive vs tax-exclusive pricing