VAT (Value-Added Tax)

1. “What is VAT?”

VAT stands for Value-Added Tax. It’s a consumption tax added to the price of goods and services at each stage of production or distribution. The final consumer pays the full amount, but businesses collect it and pass it to the government.

Imagine you’re baking a cake. At every step—flour supplier, bakery, shop—each business adds a little tax. But they also deduct the VAT they already paid. So only the “value added” at each step is taxed.

2. VAT Basics

• Indirect tax → collected by businesses, paid by consumers.

• Applied in percentages (e.g., 10%, 15%, 20%).

• Appears on invoices: Subtotal + VAT = Total.

• Two key concepts:

  • Output VAT: VAT collected on your sales.

  • Input VAT: VAT you paid on purchases.

In Accounting Terms:

• Seller’s entry:

  • Dr. Cash or Accounts Receivable

  • Cr. Sales (net)

  • Cr. VAT Payable

• Buyer’s entry:

  • Dr. Purchases (net)

  • Dr. VAT Receivable

  • Cr. Cash or Payables

VAT Payable Calculation:

VAT Payable = Output VAT – Input VAT

If Output > Input → you owe money.
If Input > Output → you get a refund.

3. Examples and Analogies

🔢 Example: Selling a product at €120 with 20% VAT

• Net sale price = €100

• VAT = €20

• Entry:

  • Dr. Cash €120

  • Cr. Sales €100

  • Cr. VAT Payable €20

🛒 Tom’s Shop (real case from Slides):

• Household items sold: €2,622 incl. VAT (20%)

• Net = €2,185; VAT = €437

• Purchases incl. VAT: €3,766 → VAT = €627.67

• Total VAT Payable = Output VAT – Input VAT = €1,278.91 – €809.49 = €469.42 VAT Payable

4. One-Minute Summary

“VAT is a consumption tax charged at every stage of the supply chain but ultimately paid by the final consumer. Businesses collect output VAT on sales and deduct input VAT from purchases. The difference is paid to or refunded by the tax authorities. It’s recorded through double-entry accounting—sales increase income and VAT payable; purchases increase expenses and VAT receivable.”