2.3 Ledger Accounts & Sales / Purchase Tax (VAT)

Ledger Structure and Organization

Once transactions have been summarized in the books of prime entry, they must be posted to the ledger accounts. A business typically maintains several ledgers to organize its accounting data efficiently.

The Nominal (General) Ledger

The nominal ledger is the main accounting record of a business. It contains all the accounts needed to produce the financial statements: assets, liabilities, capital, revenue, and expenses. The principle of double-entry bookkeeping (every transaction has a debit and a credit) applies strictly within the nominal ledger.

The accounts in the nominal ledger are often organized by a Chart of Accounts, which assigns a unique numerical code to each account category to facilitate computerized processing.

Subsidiary Ledgers (Memorandum Ledgers)

In addition to the nominal ledger, businesses dealing with many credit customers and suppliers use subsidiary ledgers. These are purely for administrative detail and do not form part of the double-entry system (they are sometimes called memorandum ledgers).

• Receivables Ledger (Sales Ledger): Contains an individual account for every credit customer. It shows exactly how much each specific customer owes. The total of all balances in this ledger should equal the balance on the 'Receivables Control Account' in the nominal ledger.
• Payables Ledger (Purchases Ledger): Contains an individual account for every credit supplier. It shows exactly how much the business owes to each supplier. The total of all balances here should equal the balance on the 'Payables Control Account' in the nominal ledger.

Accounting for Sales Tax (VAT)

Value Added Tax (VAT), or Sales Tax, is an indirect tax levied on the sale of goods and services. A VAT-registered business acts as an unpaid tax collector for the government. It charges VAT on its sales but can claim back the VAT it pays on its purchases.

Terminology

• Output VAT (Sales Tax on Sales): The VAT a business charges and collects from its customers when making sales. This money does not belong to the business; it is a liability owed to the tax authorities.
• Input VAT (Sales Tax on Purchases): The VAT a business pays to its suppliers when making purchases. For a VAT-registered business, this is an asset (a recoverable amount) from the tax authorities.
• Net Amount: The value of the goods or services excluding VAT. This is the true revenue or expense for the business.
• Gross Amount: The total amount inclusive of VAT (Net + VAT). This is the amount owed by the customer or owed to the supplier.

Calculation Methods

If the tax rate is, for example, 20%:

• If given the Net figure ($100), VAT is $100 * 20% = $20. Gross is $120.
• If given the Gross figure ($120), you must extract the VAT. Since Gross = 120% of Net, you calculate VAT as: Gross * (20/120). So, $120 * (20/120) = $20.

Accounting Entries

The most critical rule to remember is that Sales and Purchases accounts in the nominal ledger are always recorded net of recoverable VAT.

1. Credit Sale with VAT Suppose a business sells goods for $1,000 net, VAT is 20% ($200). The total invoice to the customer is $1,200.

• The customer owes the full gross amount.
• The business's revenue is only the net amount.
• The VAT is a liability owed to the tax authority.

Journal Entry:

• Dr Receivables (Gross): $1,200
• Cr Sales (Net): $1,000
• Cr Sales Tax Account (Output VAT): $200

2. Credit Purchase with VAT Suppose a business buys goods for $500 net, VAT is 20% ($100). The total invoice from the supplier is $600.

• The business owes the supplier the gross amount.
• The business's expense is only the net amount.
• The VAT is recoverable from the tax authority (an asset).

Journal Entry:

• Dr Purchases (Net): $500
• Dr Sales Tax Account (Input VAT): $100
• Cr Payables (Gross): $600

Non-Recoverable VAT

Sometimes, a business is not permitted to recover the input VAT on certain purchases (e.g., entertaining clients, or purchasing cars for private use). If the VAT is non-recoverable, the business must treat the full gross amount as the expense or asset cost.

If the business bought a non-commercial car for $10,000 plus $2,000 non-recoverable VAT:

• Journal Entry:
  • Dr Motor Vehicles (Asset): $12,000
  • Cr Cash / Payables: $12,000

The Sales Tax Ledger Account

At the end of a tax period (e.g., quarterly), the business must balance the Sales Tax Account to determine the net amount payable to, or receivable from, the tax authority.

Sales Tax Account

Dr (Input VAT / Payments)                        Cr (Output VAT / Refunds)
---------------------------------------------------------------------------
Input VAT on Purchases     $100 | Output VAT on Sales        $200
Balance c/d (Owed to Tax)  $100 |
--------------------------------|------------------------------------------
                           $200 |                            $200
--------------------------------|------------------------------------------
                                | Balance b/d                $100

• A Credit balance means Output VAT > Input VAT. The business owes money to the tax authority (a liability).
• A Debit balance means Input VAT > Output VAT. The business is owed a refund from the tax authority (an asset).

When the liability is paid to the tax authority:

• Dr Sales Tax Account
• Cr Cash at Bank