5.2 Balancing Ledger Accounts and the VAT Account

Balancing Off Ledger Accounts

At the end of an accounting period (such as a month, quarter, or year), it is necessary to calculate the balance on each ledger account in the General Ledger. This process is called "balancing off" or "balancing" the accounts. It summarizes the transactions in the account and provides a single net figure (the balance) to carry forward into the next period and to include in the trial balance.

The Step-by-Step Balancing Procedure

To balance off a T-account, follow these steps:

1. Total the Sides: Separately sum the debit (left) side and the credit (right) side of the account to determine which side has the higher total.
2. Enter the Larger Total: Write the larger of the two totals in the total boxes on both the debit and credit sides. Ensure these totals are aligned on the same horizontal line.
3. Calculate the Balancing Figure: Subtract the smaller total from the larger total. This difference is the balance carried down (balance c/d).
4. Insert Balance Carried Down (c/d): Write "Balance c/d" and the calculated balancing figure on the side of the account that had the smaller total. This acts as a plug figure to make both sides equal the total written in Step 2.
5. Draw Double Lines: Draw double underline borders below the totals on both sides to show that the period is closed.
6. Bring Down the Balance (b/d): Write "Balance b/d" (brought down) and the same balance amount on the opposite side of the account below the double lines. This is the starting balance for the new accounting period.

Worked Example: Balancing the Cash Account

Consider a Cash Account with the following transactions:

• Debit side (receipts): Sales £3,000, Capital £5,000.
• Credit side (payments): Rent £1,200, Purchases £2,000, Stationery £300.

Let's balance off this account:

• Debit total = £3,000 + £5,000 = £8,000.
• Credit total before balancing = £1,200 + £2,000 + £300 = £3,500.
• The debit side is larger (£8,000), so the total box on both sides will show £8,000.
• The balancing figure (balance c/d) is £8,000 - £3,500 = £4,500.
• We write "Balance c/d £4,500" on the credit side.
• We then bring this balance down to the debit side as "Balance b/d £4,500".

Here is how the completed T-account looks:

Dr.                               Cash Account                               Cr.
--------------------------------------------------------------------------------
Receipts (Debit)                        | Payments (Credit)
--------------------------------------------------------------------------------
Sales                    £3,000         | Rent                      £1,200
Capital                  £5,000         | Purchases                 £2,000
                                        | Stationery                  £300
                                        | Balance c/d               £4,500
--------------------------------------------------------------------------------
Total                    £8,000         | Total                     £8,000
================================================================================
Balance b/d              £4,500         |

A debit balance (like the one above) exists when the debit side exceeds the credit side, leaving a balance brought down on the debit side. An asset or expense account typically has a debit balance. A credit balance exists when the credit side exceeds the debit side, leaving a balance brought down on the credit side. Liability, capital, and income accounts typically have credit balances.

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The VAT Control Account

Value Added Tax (VAT) is a tax on transactions that is collected by VAT-registered businesses on behalf of His Majesty's Revenue and Customs (HMRC) in the UK. The VAT Control Account is a nominal ledger account in the General Ledger that tracks the amount of VAT charged to customers and the amount of VAT paid to suppliers.

Structure of the VAT Control Account

The VAT Control Account functions as a summary of all VAT transactions:

1. Output VAT (Credits): VAT charged by the business on sales (credit sales from the Sales Day Book and cash sales from the Cash Book receipts). Since the business must hand this tax over to HMRC, it represents a liability and is recorded on the credit side of the VAT Control Account.
2. Input VAT (Debits): VAT paid by the business on purchases and expenses (credit purchases from the Purchases Day Book, cash purchases from the Cash Book payments, and petty cash expenses). Since the business can reclaim this VAT from HMRC, it represents an asset and is recorded on the debit side of the VAT Control Account.
3. VAT on Sales Returns (Debits): When a credit customer returns goods, the business issues a credit note that includes VAT. This reduces the output VAT liability, so the VAT on sales returns (from the Sales Returns Day Book) is posted to the debit side of the VAT Control Account.
4. VAT on Purchases Returns (Credits): When a business returns goods to a supplier, it receives a credit note that includes VAT. This reduces the reclaimable input VAT, so the VAT on purchases returns (from the Purchases Returns Day Book) is posted to the credit side of the VAT Control Account.

T-Account Summary of VAT Postings

• Debit Side (Input/Reclaimable VAT):
  • Input VAT from Purchases Day Book (credit purchases)
  • Input VAT from Cash Book payments (cash purchases/expenses)
  • Input VAT from Petty Cash Book (small expenses)
  • VAT on Sales Returns from Sales Returns Day Book (customer returns)
• Credit Side (Output/Payable VAT):
  • Output VAT from Sales Day Book (credit sales)
  • Output VAT from Cash Book receipts (cash sales)
  • VAT on Purchases Returns from Purchases Returns Day Book (supplier returns)

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Calculating Net VAT Payable or Reclaimable

At the end of each tax period (usually quarterly or monthly), the VAT Control Account is balanced off. The net balance determines whether the business owes money to HMRC or is due a refund:

• Net VAT Payable (Credit Balance): If the total credits (Output VAT) exceed the total debits (Input VAT), the business has collected more VAT than it paid. The account will have a Balance b/d on the credit side, representing a current liability owed to HMRC.
• Net VAT Reclaimable (Debit Balance): If the total debits (Input VAT) exceed the total credits (Output VAT), the business has paid more VAT than it collected. The account will have a Balance b/d on the debit side, representing a current asset due from HMRC.

Worked Example: Net VAT Calculation

A business extracts the following VAT totals for the month of April:

• Sales Day Book Output VAT: £5,200
• Purchases Day Book Input VAT: £3,100
• Sales Returns Day Book VAT: £150
• Purchases Returns Day Book VAT: £80
• Cash Book Payments Input VAT: £450

Let's compile and balance the VAT Control Account:

• Debit Entries: Purchases Day Book VAT (£3,100) + Sales Returns Day Book VAT (£150) + Cash Book Input VAT (£450) = £3,700
• Credit Entries: Sales Day Book VAT (£5,200) + Purchases Returns Day Book VAT (£80) = £5,280
• Balancing Figure: Since the credit side (£5,280) is larger than the debit side (£3,700), the total on both sides is set to £5,280.
• Balance c/d = £5,280 - £3,700 = £1,580 (written on the debit side).
• Balance b/d = £1,580 (brought down on the credit side).

Because there is a credit balance b/d of £1,580, this represents a liability payable to HMRC. When the payment is made in the next period, the Cash Book payment will show a credit in the Bank account and a corresponding debit of £1,580 in the VAT Control Account, clearing the liability.