Double Entry Bookkeeping Lesson - Worked Example:

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Accounting for VAT

This covers:
VAT on Purchases (Input VAT) and Sales (Output VAT), Trade Creditors, Trade Debtors, Payments, Receipts, Profit / Loss

bookkeeping lesson accounting for vat

1. Understand: WHAT is VAT?

VAT - Value Added Tax - is a Sales Tax charged by adding it to the selling price of goods and services.

Only VAT-registered businesses can charge VAT.

As these businesses trade they will be paying VAT out on their purchases and receiving VAT in on their sales.

VAT-registered businesses must account seperately for this VAT as they are the collectors of VAT on behalf of the government.


2. Understand: HOW is VAT accounted for?

The difference between the VAT they receive ('Output' VAT) and the VAT they pay out ('Input' VAT) is declared on a VAT Return and that difference is settled periodically in cash with the Tax Office.

For most businesses this will mean regular payments to the tax authorities, since VAT collected in will be more than VAT paid out.

Note: VAT is usually treated as having been paid or received on the date of the invoice (the 'tax point') rather than date of actual payment.

Because the business is acting purely as a collector of VAT, the VAT payable (or receivable) is recorded as a creditor (or debtor) on the Balance Sheet, and has no impact on results.

So the double entry for INPUT VAT would be:

DEBIT (DR.)

CREDIT (CR.)

VAT a/c

(Balance Sheet)

Trade Creditor a/c

(Balance Sheet)


And the double entry for OUTPUT VAT would be:

DEBIT (DR.)

CREDIT (CR.)

Trade Debtor a/c

(Balance Sheet)

VAT a/c

(Balance Sheet)


Note: Non-VAT registered businesses cannot generally reclaim VAT on purchases so suffer it is an additional cost.


The worked example below shows the accounting entries for VAT charged on both Purchases and Sales Invoices and settlement of the subsequent liability.


3. Accounting for VAT: Worked Example

Scenario:

Zelda: Zombie Slayer has a VAT-registered slaying business - ZZS.

During April ZZS buys 100kgs of Zombie Repellant from Zombies 'R' Us  and is invoiced for £1,000 plus VAT.

In the same month she slays 23 zombies for a customer, Perfect Pet Foods (PPF).

She charges £100 per Zombie and ZZS invoices Sales of £2,300 net.

All invoices are settled by BACs payments in May.

ZZS also settles it's VAT account in May.

Vat is 20%.


Requirements:

1.  Show the double entry bookkeeping for all the transactions of ZZS.

2. Show the Account Balances at end of April and May.

Workings:

Input VAT on Purchase Invoice = £1,000 * 20% = £200

Output VAT on Sales invoice = £2,300 * 20% = £460


SOLUTION: Double Entry Accounting Entries and Balances

vat-accounting-example

Note: if ZZS was not VAT-registered, the business would not be able to reclaim the VAT on its purchases and could not charge VAT on its sales. The gross cost of the Repellant would be charged to profit which would be £200 less at £1,100.


Keeping Accounting Simple, Stupid!

One of our missions here at the Alternative Accountant is to provide simple, practical worked examples of double entry accounting across a range of real life Accounting Scenarios.

The reality of Accounting is that however sophisticated finance systems and ERP systems purport to be, the basic, simple principles of double entry accounting must - and will - always hold true.

What's more, these systems are only as good as the integrity of the processes and controls feeding them with data. As anyone who works in accounting knows, processes ALWAYS break down at some point!

A good grounding in double entry principles and mechanics is essential to understand and resolve the resulting issues and risks efficiently and correctly.


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