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Introduction

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Accounting for VAT can be broken down into two  categories:

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• Accounting for VAT on Sales or Revenue

• Accounting for VAT on Purchases 

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Accounting for VAT on Revenue

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VAT registered business providing taxable supplies of goods or services will include VAT (20%) on their invoices.  The accounting entries required for this transaction will depend on whether VAT is accounted for when the invoice is raised and sent to the customer or when the customer pays for the goods and services. 

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Where VAT is accounted for or booked to the sales ledger when an invoice is raised and sent out, the normal VAT accounting entries will be as follows:

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• DR  Debtors account (customer) on Balance Sheet

• CR  VAT Payable account (creditors) to HMRC on Balance Sheet

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The above entries will record the VAT owed by the customer to the business issuing the invoice and also the VAT owed to HMRC by the business issuing the invoice.

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When the customer settles the invoice, the closing VAT entries will normally be as follows:

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• DR Bank account on Balance Sheet  

• CR Debtors account (customer) on Balance Sheet

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The above entry records the VAT received from the customer paid into the bank account of the business and also the clearance of the VAT debtor on Balance Sheet customer account.

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The final entry will be the payment of VAT collected from the customer to HMRC and will be booked as follows to the ledgers: 

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• DR VAT Payable (creditors) to HMRC account on Balance Sheet   

• CR Bank account on Balance Sheet 

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Where VAT is accounted for or booked to the ledgers when cash is paid to the business  (cash accounting) the normal accounting entries will be as follows:

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• DR Bank account on Balance Sheet 

• CR VAT Payable (to HMRC) account

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 There are no debtor accounts under the cash accounting method as VAT is only accounted for once the cash has been received from the customer.

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The final leg of the transaction will be the payment to HMRC for the VAT collected from the customer and the VAT accounting entries will be as follows:

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• DR VAT Payable (to HMRC) account

• CR Bank account 

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The above clears the VAT payable account  to zero.

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Accounting for VAT on Purchases

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VAT (Input VAT) will be incurred on taxable purchases made by a business. This will include purchased of materials, electricity, legal and accountancy services, software, hardware such as computers and other peripherals, Assets such as motor vehicles, plant and machinery etc.   

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There are two accounting methods used to record VAT incurred on purchases, namely:

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• Gross Method

• Net Method 

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Gross Method

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Using the gross method of accounting for input VAT incurred on purchases means posting the full cost of the item(s) purchased to the expense line of the P&L (So the net value on the invoice plus the VAT will be posted).  So an invoice for £10,000 + £2,000 VAT will be posted gross to the expense line in the P&L £12,000.

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The accounting entries required for expenses purchased that include VAT will be as follows:

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• DR P&L account expense line with Gross value of invoice

• CR Creditors or Bank depending if purchases are on credit or for cash respectively

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• DR VAT Recoverable from HMRC on balance sheet

• CR P&L Account expense line with the recoverable VAT

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• DR Bank ( when HMRC Refund of VAT is received post VAT return filling)

• CR VAT Recoverable from HMRC on balance sheet

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This method is not suitable for accounting for VAT on Fixed Assets as it will result in total VAT being added to the value of Fixed Assets when acquired, thus potentially overstating them. (Unless the entity only makes exempts supplies and as such all of the VAT incurred is irrecoverable and should be included in the cost of the Fixed Asset)  

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Net Method

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Using the net method of accounting for input VAT incurred on purchases means posting the net cost of the item(s) purchased to the expense line of the P&L. ( I.e. VAT will not be posted to the same expense line)

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The VAT incurred will be posted to a Balance Sheet VAT recoverable (HMRC debtor account)

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The accounting entries required for expenses that include VAT will be as follows:

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• DR P&L account expense line with the net value of the expense (amount that excludes VAT)

• DR VAT Recovery account (HMRC debtor) on balance sheet with VAT amount on invoice

• CR Creditors or Bank with Gross invoice amount (Net plus VAT) depending if purchases are on credit or for cash respectively

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• DR P&L Expense  line with Irrecoverable VAT (the amount of VAT that can't be recovered from HMRC)

• CR VAT Recovery account (HMRC debtor) on balance sheet with the  irrecoverable VAT figure. (the amount that can't be recovered from HMRC)

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• DR Bank ( when HMRC Refund of VAT is received post VAT return filling)

• CR VAT Recoverable from HMRC on balance sheet

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Accounting for VAT on Fixed Assets

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Accounting for VAT on Fixed Assets uses the Net Method by booking only the net value of the asset plus any irrecoverable VAT to the balance sheet. Thus if the business can fully recover all its VAT then there will be no VAT to book as part of the cost of the fixed asset.

 

If a business is partially exempt in that it makes taxable (standard rated & zero rated) and exempt supplies to its customers and thus can't recover all of the VAT it has incurred on the purchase of fixed assets, then the irrecoverable VAT will need to be booked as part of the cost of the asset on balance sheet.

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Key - Irrecoverable VAT incurred on the purchase of Fixed Assets is part of the cost of the Fixed Asset and must be posted along with the net cost to the Balance Sheet Fixed Asset account.

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The typical VAT accounting entries for Fixed Assets are shown below:

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• DR Fixed Asset account on balance sheet with the net cost 

• DR VAT Recovery account (HMRC debtor) on balance sheet with VAT amount on invoice

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• DR Fixed Asset account with Irrecoverable portion of the VAT

• CR VAT Recovery account

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• DR Bank ( when HMRC Refund of VAT is received post VAT return filling)

• CR VAT Recoverable from HMRC on balance sheet

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 Accounting for Reverse Charge VAT on Costs

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Accounting for Reverse Charge VAT means the business will have to self account for output and input VAT by multiplying the total value of the invoice received from the non UK vendor by 20% then booking this amount to the output VAT account on balance sheet and an equal amount of Input VAT to either the P&L cost account line or to the balance sheet VAT recoverable account depending on whether the gross or net method of accounting is used respectively.

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Note if the business only makes taxable supplies, then the input VAT will be fully recoverable from HMRC and as such there will be nothing to pay HMRC as shown in box 5 on the VAT return.  If the business makes both taxable and exempt supplies then the input VAT incurred will be partially recoverable and this the difference between the output VAT and input VAT that is recoverable will be the amount payable to HMRC as shown in Box 5 on the VAT return

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The typical VAT accounting entries used for accounting for  reverse charge are as follows:  

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Gross Method

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• DR   P&L account expense line with Reverse Charge VAT amount

• CR   Reverse Charge Output VAT account (BS) with Reverse Charge Amount​

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• DR   VAT Recoverable (BS) from HMRC  (Recoverable portion of reverse charge VAT)

• CR   P&L Account expense line with the recoverable portion of Reverse Charge VAT

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• DR   Reverse Charge Output VAT account (BS) to transfer balance to VAT control account

• CR   VAT Control Account (BS) with reverse charge output VAT

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• DR   VAT Control Account with recoverable reverse charge VAT

• CR VAT Recoverable (BS) transfer of balance to VAT Control Account

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Note: if the Reverse Charge VAT is fully recoverable then no more accounting entries will be required as the control account will now contain the Reverse Charge Output VAT and Reverse charge Input VAT and they will net off. (no payment due to HMRC)

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Where the Reverse Charge VAT is not fully recoverable due to the business being partially exempt, then the closing entry will be to pay HMRC the balance between the Reverse Charge output VAT less the recoverable Reverse Charge input VAT as follows:

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• DR   VAT Control Account (payment to HMRC)

• CR   Bank (payment to HMRC)

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Net Method

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• DR  BS VAT Recoverable account with Reverse Charge VAT amount

• CR  BS Reverse Charge Output VAT account

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• DR P&L Expense  line with Irrecoverable portion of Reverse Charge VAT (the amount of VAT that can't be recovered from HMRC)

• CR VAT Recovery account (HMRC debtor) on balance sheet with the  irrecoverable VAT figure. (the amount that can't be recovered from HMRC)

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• DR   Reverse Charge Output VAT account (BS) to transfer balance to VAT control account

• CR   VAT Control Account (BS) with reverse charge output VAT

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• DR   VAT Control Account with recoverable reverse charge VAT

• CR VAT Recoverable (BS) transfer of balance to VAT Control Account

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Note: if the Reverse Charge VAT is fully recoverable then no more accounting entries will be required as the control account will now contain the Reverse Charge Output VAT and Reverse charge Input VAT and they will net off. (no payment due to HMRC)

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Where the Reverse Charge VAT is not fully recoverable due to the business being partially exempt, then the closing entry will be to pay HMRC the balance between the Reverse Charge output VAT less the recoverable Reverse Charge input VAT as follows:

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• DR   VAT Control Account (payment to HMRC)

• CR   Bank (payment to HMRC)

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