Journal entries for Value Added Tax – (VAT)

The first important concept to understand is that VAT payment is not an expense for the manufacturer, trader, retailer, or anyone else in the supply chain. This payment is an expense only for the consumer who will consume the product/services at the end of supply chain.

Let’s review accounting entries for the VAT validated for all except consumers.

When paying VAT on purchasing

When paying VAT to the supplier, the following journal entries will be posted in the accounting system.

Transaction description	Debit	Credit
VAT receivable (asset)	XXX
Bank (asset)		XXX

The debit impact of the given journal entry is recording an asset in the accounting record, as this payment will be recovered/claimed via a sales tax return. On the other hand, the credit impact is reducing the bank as the business has paid cash via bank.

Throughout the month, we record VAT receivable, as this payment will be claimed in the next sales tax return.

When Receiving VAT on selling

The following journal entries are recorded in the accounting system when making sales.

Transaction description	Debit	Credit
Bank (asset)	XXX
VAT Payable (liability)		XXX

The debit impact of the given transaction is increasing cash balance as the business has received this amount from the customer. On the other hand, the credit impact is increasing liability as this amount does not belong to business income. Instead, the business has just collected it on behalf of the tax authority, and they must pay back the same amount to the tax authority at the end of accounting month. Hence, it remains a liability until paid to the tax authority.  

The above accounting treatment is valid from the perspective of manufacturers, traders, retailers, etc. However, it’s different for the consumer, who ultimately bears this expense.

VAT accounting treatment for consumer

Let’s go through the accounting treatment of VAT from the perspective of the consumer.

Transaction description	Debit	Credit
Cost of sales (expense)	XXX
Bank		XXX

The debit impact of this transaction is recording tax expense, as it’s an expense for the consumer because they are not going to get it claimed from anywhere. So, this expense reduces business profit. On the other hand, the credit impact is reduced bank as payment was made using a bank account.

Conclusion

Value-added tax is ultimately an expense for the consumer only. Businesses in the supply chain, such as manufacturers, traders, and retailers, pay and claim this payment in the sales tax return. However, consumers are not able to claim this payment. Hence, they must record it as an expense.

For manufacturer, trader, retailers, when paying VAT, this amount is recorded as asset as this will be claimed in the next sales tax return. On the contrary, when receiving VAT from customers, it will be recorded as liability because they must pay back the amount to the tax authority at the end of month.