VAT Entries: Input VAT, Output VAT and Settlement

Why an English guide to VAT

The US has no value added tax: its states and cities levy a sales tax instead, and the US convention on PractiBalance follows that. But many learners who study in English work with VAT (in the UK, Ireland and across the European Union), and PractiBalance lets you switch to the Spanish, French or German convention, where almost every purchase and sale has a VAT line. This guide explains the VAT entries in generic English terms and then contrasts them with US sales tax.

How VAT works

VAT is charged at every stage of the supply chain, but each business pays only on the value it adds:

• When a business sells, it adds VAT to its price and collects it from the customer. This is output VAT: money that belongs to the tax authorities, so it is a liability.
• When a business buys goods or services for its activity, it pays VAT to its supplier. This is input VAT: the business can normally deduct it from the output VAT it owes, so it is an asset (a claim on the tax authorities).
• At the end of each tax period the business offsets the two and pays the difference (output VAT greater than input VAT) or claims it back or carries it forward (input VAT greater).

VAT is therefore not a cost and not revenue for a business that can deduct it. Purchases are recorded at their net amount, sales at their net amount, and the VAT goes to its own accounts. Input VAT that cannot be deducted (for some exempt activities or excluded expenses) is part of the cost of what was bought.

The general rates in the conventions on this site are 21% in Spain, 20% in France and 19% in Germany; each country also has reduced rates. The examples below use 20% to keep the arithmetic simple.

Worked examples

1. Buying goods on credit

A retailer buys goods for resale for 1,000 plus 20% VAT (200), payable in 30 days. Under a periodic inventory system, as used in Europe, the net amount goes to Purchases.

Account	Debit	Credit
Purchases	1,000
Input VAT	200
Accounts Payable		1,200

The supplier is owed the gross amount, 1,200.

2. Selling goods on credit

The retailer sells goods for 3,000 plus 20% VAT (600).

Account	Debit	Credit
Accounts Receivable	3,600
Sales Revenue		3,000
Output VAT		600

Revenue is the net price, 3,000. The 600 is collected on behalf of the tax authorities.

3. Settling the period

At the end of the period, output VAT is 600 and input VAT is 200, so 400 is due. The settlement closes both accounts and records the amount owed; the payment follows when the return is filed.

Account	Debit	Credit
Output VAT	600
Input VAT		200
VAT Payable		400

When the 400 is paid, VAT Payable is debited and Cash (or Bank) credited. Some textbooks record the settlement and the payment in one entry, crediting Bank directly for 400; the net effect is the same. If input VAT is larger than output VAT, the difference is debited to a VAT receivable account instead and is refunded or carried forward to the next period.

Accounts in each convention

Convention	Input VAT	Output VAT	Balance due	Balance in favor
Spain (PGC)	472 Hacienda Pública, IVA soportado	477 Hacienda Pública, IVA repercutido	4750 Hacienda Pública, acreedora por IVA	4700 Hacienda Pública, deudora por IVA
France (PCG)	44566 TVA sur autres biens et services (44562 TVA sur immobilisations on fixed assets)	44571 TVA collectée	44551 TVA à décaisser	44567 Crédit de TVA à reporter
Germany	Vorsteuer	Umsatzsteuer	Umsatzsteuer-Zahllast (paid by bank)	Vorsteuerüberhang (refund claim)

France is the only one of the three charts with a separate input VAT account for fixed assets. In Germany the input VAT is usually transferred to the Umsatzsteuer account (“Umsatzsteuer an Vorsteuer”) and the remaining balance is the Zahllast paid to the tax office.

The US contrast: sales tax

US sales tax is a single-stage tax charged on sales to the final consumer, at rates set by each state and local government. It works differently from VAT in three ways that change the entries:

• On sales, the seller collects the tax and owes it to the state: it is credited to Sales Tax Payable, a liability, never to revenue.
• Goods bought for resale are usually exempt (the buyer gives the seller a resale certificate), so the retailer pays no tax on its inventory purchases.
• On items a business buys for its own use, the sales tax it pays is not recoverable. It is part of the cost: sales tax on equipment is debited to Equipment, on supplies to the supplies account. There is no input tax account.

4. A US sale with sales tax

A store sells goods for $1,000 on account in a state with a 6% sales tax.

Account	Debit	Credit
Accounts Receivable	1,060
Sales Revenue		1,000
Sales Tax Payable		60

Under the perpetual system of the US convention, a second entry moves the cost of the goods sold from Inventory to Cost of Goods Sold. When the store remits the tax, it debits Sales Tax Payable and credits Cash for $60.

Common mistakes

• Recording the gross amount as revenue or as purchases. The tax belongs in its own account.
• Recording input VAT as an expense when it is deductible.
• Crediting input VAT on a sale or debiting output VAT on a purchase: input VAT comes with purchases, output VAT with sales.
• In the US convention, creating a recoverable input tax account: sales tax paid on a business purchase becomes part of the cost.

Practice

Switch the convention to Spain, France or Germany and try the VAT items in purchases, sales and fixed assets; the US convention practices sales tax in the sales family. See also the journal entries guide and the glossary.