8. Accounting for VAT Flashcards
What is VAT?
Value added tax (VAT) is an indirect tax on the supply of goods and services.
Tax is collected at each transfer point in the chain from prime producer to final consumer.
Eventually, the consumer bears the tax in full and any tax paid earlier in the chain can be recovered by a registered trader who paid it.
How is VAT collected?
Although it is the final consumer who eventually bears the full VAT of £400, the sum is collected and paid by the traders who make up the chain, provided they are registered for VAT.
Each trader must assume that his customer is the final customer:
They must collect and pay over VAT at the appropriate rate on the full sales value (known as output tax) of the goods sold.
They are normally entitled to reclaim VAT paid on his own purchases of goods, expenses and non-current assets (known as input tax) and so makes a net payment to the HMRC equal to the tax on value added by himself.
What is an non-registered trader?
Traders whose sales (outputs) are below a certain level need not register for VAT although they may do so voluntarily.
Unregistered traders neither charge VAT on their outputs nor are entitled to reclaim it on their inputs. They are in the same position as a final consumer.
How may the outputs of registered traders be classified?
All outputs of registered traders are either taxable or exempt.
What is an exempt activity?
Traders carrying on exempt activities (such as banks) cannot charge VAT on their outputs and consequently cannot reclaim VAT paid on their inputs.
Taxable outputs are chargeable at what three rates?
- Zero rate (on printed books and newspapers for instance)
- Reduced rate (5% on domestic fuel)
- Standard rate: 20%
How frequently do businesses submit a tax return to HMRC? What does it depend upon? (4)
The frequency with which businesses prepare a VAT return and make payments to/reclaim amounts from HMRC depends on:
1. The amount of the taxable sales of the business
2. The type of business
3. The history of preparing VAT returns on time
4. The history of making payments on time.
What is the general principle for the treatment of VAT in the ledger accounts?
As a general principle, the treatment of VAT in the trader’s ledger accounts should reflect the trader’s role as tax collector, so VAT should not be included in income or expenses, whether of a capital or a revenue nature.
How should irrecoverable VAT be treated in the statement of profit or loss?
Where a trader suffers irrecoverable VAT as a cost, VAT should be included as an expense (it cannot be claimed as an input tax).
How will a trader not registered for VAT be affected by it?
Traders not registered for VAT will suffer VAT on inputs as a cost. This will increases their expenses and the cost of any non-current assets they purchase.
How may a registered trader carrying on exempted activities be affected by VAT?
Registered traders who also carry on exempted activities may suffer VAT on certain inputs. This will increase the expense in respect of these inputs.
Give two examples of non-deductible inputs and the VAT implications of these for a trader.
Non-deductible inputs will be borne by all traders:
1. VAT on cars purchased and used in the business is not reclaimable (VAT on a car acquired new for resale, i.e., by a car trader, is reclaimable)
2. VAT on business entertaining is not deductible as input tax other than VAT on entertaining staff.
Where VAT is not recoverable, how must it be accounted for?
Where VAT is not recoverable it must be regarded as part of the cost of the items purchased and included in the statement of profit o loss or statement of financial position as appropriate.
How is VAT charged in the case of a trade discount or early settlement discount is given?
If a trade discount is given, VAT is charged on the sale amount net of the trade discount.
If an early settlement discount is offered at the point of sale, output VAT is accounted for on the amount that is actually received from the customer.
As a result, customer can receiver VAT only on the actual amount paid to the supplier.
What are the two options for a business when preparing an invoice that includes discounts and VAT?
- The supplier issues an invoice with VAT calculated on the sale price ignoring any offered early settlement discount and records it in the normal way. If the the customer takes up the early settlement discount, the supplier will issue a credit note for the amount of the discount, including VAT the VAT on this.
- Alternatively, if the supplier does not wish to issue credit notes for this type of transaction, it must issue an invoice which states the full value of the transaction, including any VAT and a footnotes which details the terms of the early settlement discount, and a statement that the customer can only recover as input tax, the VAT paid to the supplier.
(The second option is assumed throughout the Accounting Course)
