Chapter 4: Ledger Accounting and Double Entry PDF

# Chapter 4: Ledger Accounting and Double Entry ## Introduction - **Learning Outcomes** - Identify the sources of information for the preparation of accounting records and financial statements. - Record and account for transactions and events resulting in income, expenses, assets, liabilit...

# Chapter 4: Ledger Accounting and Double Entry ## Introduction - **Learning Outcomes** - Identify the sources of information for the preparation of accounting records and financial statements. - Record and account for transactions and events resulting in income, expenses, assets, liabilities, and equity, in accordance with the appropriate basis of accounting and the laws, regulations, and accounting standards applicable to the financial statements. - Prepare journals for nominal ledger entry and correct errors in draft financial statements. - **Syllabus Links** - Material in this chapter will be developed further throughout the Accounting module, and then in Professional Level Financial Accounting and Reporting. - **Examination Context** - Questions on the topics in this chapter will be set as multiple choice questions, multi-part multiple choice, or multiple-response questions, some of which may involve calculations. - Very often double-entry questions are phrased in terms of preparing a journal entry. - In the exam, you may be required to: - Identify the effect of debit and credit entries in ledger accounts for the elements of financial statements. - Specify the double entry needed to record particular transactions. - Identify entries in ledger accounts for VAT, payables, and receivables. ## 1 Ledgers ### Section Overview - The nominal ledger, receivables ledger, and payables ledger are the main ledgers used in an accounting system. - Records should be kept in ledgers in chronological order, with cumulative totals built up. ### 1.1 **Use of Ledgers** - A business continually enters into transactions such as buying and selling goods, paying credit suppliers, and collecting cash from credit customers. - To prepare financial statements on the completion of every individual transaction would be a time-consuming and cumbersome administrative task. - Instead, businesses use ledgers to record and analyze the transactions undertaken. - When the time comes to prepare the financial statements, the relevant information can be extracted easily from the ledgers. - The transactions in ledger accounts should be recorded: - In chronological order and dated so that transactions can be related to a particular period of time. - Built-up in cumulative totals. - Day by Day (e.g., total sales on Monday, total sales on Tuesday) - Week by Week - Month by Month - Year by Year ## 2 The Nominal Ledger ### Section Overview - The nominal ledger is the main accounting record in which financial transactions are recorded. - The nominal ledger contains several ledger accounts that represent each of the categories of asset, liability, capital, income, and expense of a business. - A 'T-account' is one way of recording which ledger accounts are affected by transactions. - In a T-account, the left-hand side is the debit side, and the right-hand side is the credit side. ### 2.1 **What is the nominal ledger used for?** - The nominal ledger contains details of assets, liabilities, capital, income, and expenditure, and therefore profit and loss. - It consists of a large number of different ledger accounts, each account having its own purpose or 'name,' and an identity or code. - In a computerized accounting system, each ledger account is assigned a unique code. - The codes are normally assigned in such a way that related or similar ledger accounts will have consistent coding. - For example, administrative expenses may have the code 100000, telephone expenses may be 100100, rent expenses 100200, etc. - This means that the expense categories will appear sequentially when data is extracted from the accounting system (see Chapter 5). - Examples of ledger accounts in the nominal ledger include: - Plant and machinery at cost (non-current asset) - Plant and machinery, accumulated depreciation (deduction from non-current asset) - Motor vehicles at cost (non-current asset) - Motor vehicles, accumulated depreciation (deduction from non-current asset) - Owner's capital (capital) - Inventories (current asset) - Trade receivables (current asset) - Trade payables (current liability) - Wages and salaries (expense) - Rent and local taxes (expense) - Advertising expenses (expense) - Bank charges (expense) - Motor expenses (expense) - Telephone expenses (expense) - Sales (income) - Total cash/bank overdraft (current asset/liability) - A computerized accounting system will use the code assigned to each nominal ledger account to automatically classify each account into the elements of the financial statements. - The income and expense ledger accounts will together form the statement of profit or loss, while the asset, capital, and liability ledger accounts will together form the statement of financial position. ### 2.2 **The Format of a Ledger Account** - An accounting record captures more than the amount of the transaction. - At a minimum it will record the date, the amount of the transaction, and a short description of the other side of the double entry. - It may also include a unique reference number and/or a brief description of the transactions. - Throughout Accounting and elsewhere in your ICAB studies, we will use a T-account format to present the entry of a transaction into a ledger account. ## 3 Double-Entry Bookkeeping ### Section Overview - The principle of double-entry bookkeeping is that, for each transaction, every debit entry has an equal credit entry. - Debit entries increase assets and expenses, and decrease liabilities, capital, and income. - Credit entries increase liabilities, capital, and income, and decrease assets and expenses. - A receipt of cash is a debit in the cash at bank account. - A payment of cash is a credit in the cash at bank account. - A credit sale is recorded as debit receivables (increase asset), credit sales (increase income). - A credit purchase is recorded as debit purchases (increase expenses), credit payables (increase liabilities). ### Definition - Double-entry bookkeeping: Each transaction has an equal but opposite effect. - Every accounting event must be entered in ledger accounts both as a debit and a credit. ### 3.1 Dual Effect (Duality Concept) - Double-entry bookkeeping is the method used to record transactions in the nominal ledger accounts. - Central to this process is the idea that every transaction has two effects, the dual effect (also known as the duality concept). - For instance, if you were to purchase a car for CU1,000 cash, you would be affected in two ways: - You own a car (an asset) worth CU1,000. - You have CU1,000 less cash (an asset). - If instead, you got a bank loan to make the purchase: - You own a car (an asset) worth CU1,000. - You owe the bank CU1,000 (a liability). - A month later, if you pay a garage CU50 to have the exhaust repaired: - You have CU50 less cash (an asset). - You have incurred a repairs expense (an expense) of CU50. - Ledger accounts, with their debit and credit sides, are kept in a way which allows the two-sided nature of every transaction to be recorded. - This is known as double-entry bookkeeping because every transaction is recorded twice in the ledger accounts. ### 3.2 The Rules of Double-Entry Bookkeeping - A debit entry will: - Increase an asset - Increase an expense - A credit entry will: - Decrease a liability - Decrease capital - Decrease income - The basic rule, which must always be observed, is that every financial transaction gives rise to (at least) two accounting entries, one a debit and the other a credit. - The total value of debit entries in the nominal ledger is therefore always equal to the total value of credit entries. - Which account receives the credit entry and which receives the debit entry depends on the nature of the transaction. - An increase in an expense (e.g., a purchase of stationery) or an increase in an asset (e.g., a purchase of office furniture) is a debit. - An increase in income (e.g., a sale) or an increase in a liability (e.g., buying goods on credit) or capital is a credit. - A decrease in an asset (e.g., making a cash payment) or a decrease in an expense is a credit. - A decrease in a liability (e.g., paying a credit supplier) or capital or income is a debit. ### 3.3 Double Entry for Cash Transactions - A cash payment is a credit entry in the cash at bank account. - Here cash (an asset) is decreasing. - Cash may be paid out, for example, to pay an expense (such as insurance) or to purchase an asset (such as a machine). - The matching debit entry is therefore made in the appropriate expense or asset account. - A cash receipt is a debit entry in the cash at bank account. - Here cash (an asset) is increasing. - Cash might be received, for example, by a retailer who makes a cash sale. - The credit entry would then be made in the revenue (income) account (and the VAT account if relevant). ### 3.4 Double Entry for Credit Transactions - Not all transactions are settled immediately. - A business can purchase goods or non-current assets on credit terms, so that balances owed to suppliers would be trade payables until settlement was made in cash at a later date. - Equally, the business might grant credit terms to customers, so the balances owed by customers would then be trade receivables of the business. - No entries are made in the cash at bank account when a credit transaction occurs, because no cash has been received or paid. - Instead, we use receivables and payables accounts. - When a business acquires goods or services on credit, the credit entry is posted to the 'trade payables' account instead of the cash account. - The debit entry is posted to the expense or asset account, exactly as in the case of cash transactions. - Similarly, when a sale is made to a credit customer, the entry is a debit to the trade receivables account (instead of cash account), and a credit to the sales account. ## 4 Journal Entries ### Section Overview - Journal entries have a particular format that you should use. - Journals can be used to record any type of financial transaction, but are mainly used to record transactions that are one-off or unusual in nature. ### 4.1 What Are Journal Entries Used For? - A journal entry is a way of presenting the required double entry (debits and credits) for a transaction. - Any transaction can be represented by a journal entry. - However, journal entries are generally used to record unusual or one-off transactions, such as the correction of an error (covered in Chapter 6). - In the Accounting exam, you may be asked for the journal entry to record a particular transaction. - For whatever type of transaction is being recorded, the format of a journal entry is as follows: - **Date** - **Account to be debited** - **Debit CU** - **Account to be credited** - **Credit CU** - A narrative explanation should accompany each journal entry, which is required for audit and control, to indicate the purpose and authority of every transaction. - A computerized accounting system will not allow a journal entry to be processed if the debit entries do not equal the credit entries. ### 4.1 Worked Example: Journal Entries to Record Transactions - The following is a summary of the transactions of Hair, a sole trader-owed hairdressing business: | Date | Transaction | |---|---| | 1 January | Put in cash of CU20,000 as capital | | 1 January | Purchased fixtures and fittings for cash of CU5,000 | | 30 January | Purchased equipment on credit for CU2,000 | | 30 January | Paid three months' rent to 31 March CU1,500 | | 31 January | Collected and paid in takings CU600 | | 31 January | Gave a regular customer a hair treatment for CU80 on credit | | 31 January | Took out CU100 for personal expenses | - **Journal** | Date | Account to be Debited | Debit CU | Account to be Credited | Credit CU | Description | |---|---|---|---|---|---| | 1 January | Cash at bank account | 20,000 | Capital account - Initial capital introduced | 20,000 | | | 1 January | Fixtures and fittings (non-current asset) | 5,000 | Cash at bank account - The purchase for cash of fixtures and fittings | 5,000 | | | 1 January | Equipment (non-current asset) | 2,000 | Trade payables - The purchase of equipment on credit | 2,000 | | | 30 January | Rent expense account | 1,500 | Cash at bank account | 1,500 | The payment of rent to 31 March | | 30 January | Cash at bank account | 600 | Sales account | 600 | Cash takings | | 31 January | Trade receivables | 80 | Sales account | 80 | The provision of hair treatment on credit | | 31 January | Drawings | 100 | Cash at bank account | 100 | Owner's drawings | ## 5 Double Entry for Petty Cash ### Section Overview - The double entry for transactions recorded in the petty cash book involves an entry to the petty cash account and the relevant expense category. ### 5.1 Double Entry for Petty Cash Transactions - In Chapter 3, we saw how the petty cash book is used to record petty cash transactions. - A business starts with a cash float (imprest) on 1.3.20X7 of CU250. - This will be a payment from cash at bank to petty cash: - **Journal** | Account to be Debited | Debit CU | Account to be Credited | Credit CU | |---|---|---|---| | Petty cash | CU250 | Cash at bank | CU250 | - Suppose five payments were made out of petty cash during March 20X7, none of which attracted VAT. - The petty cash book might look as follows: | Date | Narrative | Total Payments CU | Postage CU | Travel CU | |---|---|---|---|---| | 1.3.X7 | Cash | 250.00 | | | | 2.3.X7 | Stamps | | 12.00 | | | 8.3.X7 | Stamps | | 10.00 | | | 19.3.X7 | Travel | | | 16.00 | | 23.3.X7 | Travel | | | 5.00 | | 28.3.X7 | Stamps | | 11.50 | | | **Total** | | **54.50** | **33.50** | **21.00** | - At the end of each month (or at any other suitable interval), the total payments in the petty cash book are posted to the appropriate nominal ledger accounts. - This just means that the totals of the columns are entered as debit and credit entries in the ledger accounts. - For March 20X7, CU33.50 would be debited to the postage account and CU21.00 to the travel account. - The total payments of CU54.50 are credited to the petty cash account. - The amounts are recorded using the following journal entry: - **Journal** | Account to be Debited | Debit CU | Account to be Credited | Credit CU | |---|---|---|---| | Postage | 33.50 | Petty Cash | 54.50 | | Travel | 21.00 | | | - Next, the cash float needs to be topped up to the imprest amount by a payment of CU54.50 from the business bank account: - **Journal** | Account to be Debited | Debit CU | Account to be Credited | Credit CU | |---|---|---|---| | Petty Cash | CU54.50 | Cash at bank | CU54.50 | - So double entry rules have been satisfied, and the petty cash book for the month of March 20X7 will look like this: | Date | Narrative | Total Payments CU | Postage CU | Travel CU | |---|---|---|---|---| | 1.3.X7 | Cash | 250.00 | | | | 2.3.X7 | Stamps | | 12.00 | | | 8.3.X7 | Stamps | | 10.00 | | | 19.3.X7 | Travel | | | 16.00 | | 23.3.X7 | Travel | | | 5.00 | | 28.3.X7 | Stamps | | 11.50 | | | 31.3.X7 | Balance carried down (c/d) | 195.50 | 33.50 | 21.00 | | 1.4.X7 | Balance brought down (b/d) | 195.50 | | | | 1.4.X7 | Cash | 54.50 | | | | **Total** | **250.00** | **250.00** | **33.50** | **21.00** | - The cash float is back up to (CU195.50 + CU54.50) = CU250 imprest on 1.4.X7, ready for more payments to be made. - The petty cash account in the nominal ledger will be as follows: | Date | Account | CU | |---|---|---| | 1.3.20X7 | Cash | 250.00 | | 31.3.20X7 | Payments | 54.50 | | 1.4.20X7 | Cash | 54.50 | | 1.4.20X7 | Balance b/d | 250.00 | | **Total** | **304.50** | **304.50** | ## 6 The Receivables and Payables Ledgers ### Section Overview - The receivables ledger is where the individual ledger accounts for each credit customer (personal accounts) are listed. - A total receivables account is held in the nominal ledger, called trade receivables. - The payables ledger is where the individual ledger accounts for each credit supplier (personal accounts) are listed. - A total payables account is held in the nominal ledger, called trade payables. ### 6.1 Nominal Ledger Accounts and Personal Accounts - Nominal ledger accounts relate to types of income, expense, asset, capital, and liability (rent, sales, trade receivables, payables, and so on), but do not record individual details relating to the person or business to whom the money is paid or from whom it is received. - Therefore, there is also a need for personal accounts, most commonly for receivables and payables, and these are contained in the receivables ledger and the payables ledger. - These are memorandum accounts only, in memorandum ledgers; they are not part of the double-entry system. - Instead, trade receivables and trade payables accounts are kept in the nominal ledger, which records the totals of the receivables and payables ledgers. - In a computerized accounting system, sales and purchase invoices, credit notes, and payments are recorded in the receivables and payables ledgers which will then automatically update trade receivables and trade payables in the nominal ledger. - The total of the individual accounts in the receivables ledger at any point in time will be exactly equal to the total included in trade receivables, and the same will apply to the individual accounts in the payables ledger and trade payables. ### 6.2 Receivables Ledger - A business must also keep a record of how much money each individual credit customer owes, and what this total debt consists of. - The need for a separate account (sometimes referred to as a 'personal account') for each customer is a practical one. - A customer might ask how much they currently owe. Staff must be able to tell them. - It is a common practice to send out statements to credit customers at the end of each month, showing how much they owe, and itemising new invoices or credit notes sent out and payments received during the month. - The business managers will want to check the credit position of individual customers, and to ensure that no customer is exceeding their credit limit. ### 6.3 Payables Ledger - The payables ledger, like the receivables ledger, consists of a number of personal accounts. - These are separate accounts for each individual supplier, and they enable a business to keep a continuous record of how much it owes each supplier at any time. ## 7 Accounting for Discounts ### Section Overview - A trade discount is a percentage discount deducted from the list price of goods, owing to the nature of the trading transaction. - An early settlement discount is a discount offered to credit customers/offered by credit suppliers, which can be taken if an invoice is paid within a required time frame. - Sales are recorded net of trade discounts and, if they are taken, net of early settlement discounts. - Similarly, purchases are recorded net of trade discounts, and if they are taken, net of early settlement discounts. - There are two types of discount: trade discounts and early settlement discounts. ### 7.1 Trade Discount ### Definition - Trade discount: A percentage discount deducted from the list price of goods owing to the nature of the trading transaction. - A trade discount is a reduction in the amount of money initially demanded on an invoice. ### 7.1.1 Examples of Trade Discount - A customer is quoted a price of CU1 per unit for a particular item, but a lower price of 95p per unit, if the item is bought in quantities of 100 units or more at a time. - This is sometimes called a bulk discount. - An important customer or a regular customer is offered a discount on all the goods they buy, regardless of the size of each individual order, because the total volume of their purchases over time is so large. ### 7.1.2 Accounting for Trade Discounts - Purchases should be recorded net of trade discounts received from suppliers. - Sales should be recorded net of trade discounts given to customers. - Trade discounts should be deducted before any early settlement discount is calculated. ### 7.2 Early Settlement Discounts - Businesses often offer discounts to credit customers to encourage them to settle amounts owed more quickly. - These are known as early settlement discounts, prompt payment discounts, or sometimes cash discounts. ### Definition - Early settlement discount: A percentage reduction in the amount payable in return for payment within an agreed period. - A customer can choose whether or not to take an early settlement discount offered by a supplier. - If the customer decides to take the early settlement discount, the amount they must pay is reduced, provided they pay within the required timeframe. - If the customer decides not to take the discount, they must pay the full amount of the invoice but will have a longer period in which to pay. - For example, a supplier charges CU1,000 for goods with a normal credit period of 30 days but offers a discount of 5% if the goods are paid for within 10 days of the invoice date. - If the customer decides to take the discount, they must pay CU950 (CU1,000 × 95%) within 10 days of the invoice date. - If the customer decides not to take the discount, they must pay the full CU1,000 but have 30 days in which to make the payment. ### 7.2.1 Accounting for Early Settlement Discounts Offered to Customers - Sales should be recorded net of early settlement discounts taken by customers. - However, at the point of invoice, when the sale is recorded in the accounting system, the business does not know whether or not the customer will take the early settlement discount offered. - Therefore, when the sale is recorded, the business should determine whether they expect the customer to take the discount, or not, based on their knowledge of the customer and whether the customer has previously taken advantage of such discounts, and record the sale accordingly. - If, when payment is made, the customer does not behave as expected, e.g., does take a discount when they were not expected to, the accounting records are adjusted to reflect the full gross value of the goods sold. ### 7.2.2 Accounting for Early Settlement Discounts Received from Suppliers - Accounting for early settlement discounts offered to a business by its suppliers is consistent with the approach described above. - Any early settlement discount received is offset against purchases or other appropriate expense category. - A judgement should be made when the invoice is recorded as to whether or not the business is likely to take advantage of the early settlement discount offered. ### 7.2.3 Summary of Accounting Treatment for Early Settlement Discounts | | Discounts Offered to Customers | Discounts Received from Suppliers | |---|---|---| | Early settlement discount is expected to be taken | Deduct the amount of the discount when recording the revenue and receivable. If payment is not received within agreed terms and discount is not taken, increase revenue by the amount of the discount. | Deduct the amount of the discount when recording the expense and payable. If payment is not made within agreed terms and discount is not received, increase the expense by the amount of the discount. | | Early settlement discount is not expected to be taken | Do not deduct the amount of the discount when recording the revenue and receivable. If the discount is unexpectedly taken, reduce the revenue and receivable accordingly. | Do not deduct the discount when recording the expense and payable. If the discount is unexpectedly taken, reduce the expense and payable accordingly. | - Trade discounts should be deducted before any cash discount is calculated. ## 8 Accounting for VAT ### Section Overview - Standing data in computerised accounting systems will include a business' VAT registration number and applicable VAT rates. - This information is used to automatically calculate and record VAT on invoices. - A computerised accounting system will also support accurate record keeping for VAT purposes. - VAT on sales (output VAT) is debited to receivables and credited to the VAT control account (it is owed to Commissioner, VAT). - VAT on purchases (input VAT) is debited to the VAT control account (it is due from Commissioner, VAT) and credited to payables. - The net amount of VAT owed to NBR is paid to Commissioner of VAT regularly. ### 8.1 What is VAT? - Value added tax (VAT) is an indirect tax on the supply of goods and services. - Tax is collected at each transfer point in the chain from prime producer to final consumer. - Eventually, the consumer bears the tax in full and any tax paid earlier in the chain can be recovered by a registered trader who paid it. ### 8.2 How is VAT Collected? - Although it is the final consumer who eventually bears the full VAT of CU300, the sum is collected and paid by the traders who make up the chain, provided they are registered for VAT. - Each trader must assume that his customer is the final consumer: - They must collect and pay over VAT at the appropriate rate on the full sales value (known as output tax) of the goods sold. - They are normally entitled to adjust VAT paid on his own purchases of goods, expenses, and non-current assets (known as input tax) and so makes a net payment to the Commissioner, VAT equal to the tax on value added by himself. - In the example above, the supplier of raw materials collects from Aruba Ltd output VAT of CU150, all of which they pay over to Commissioner, VAT. - When Aruba Ltd sells goods to Beach plc, output VAT is charged at the rate of 15% on CU1,600 = CU240. - Only CU90, however, is paid by Aruba Ltd to Commissioner, VAT, because the company is entitled to deduct input tax of CU150 suffered on its own purchases. - Similarly, Beach plc must charge its customers CU300 in output VAT, but need only pay over to Commissioner, VAT the net amount of CU60 after deducting the CU240 input VAT suffered on its purchase from Aruba Ltd. ### 8.3 Registered and Non-Registered Traders - Traders whose sales (outputs) are below a certain level need not register for VAT although they may do so voluntarily. - Unregistered traders neither charge VAT on their outputs nor are entitled to reclaim VAT on their inputs. - They are in the same position as a final consumer. - All outputs of registered traders are either taxable or exempt. - Traders carrying on exempt activities (such as meat of sheep or goats) cannot charge VAT on their outputs and consequently cannot reclaim VAT paid on their inputs. - Taxable outputs are chargeable at one of three rates: - Zero Rate (on any goods and services exported from Bangladesh) - Reduced Rate (1.5% on residential apartments) - Standard Rate (15%) - Commissioner, VAT, identifies supplies falling into each category. - Persons carrying on taxable activities (even activities taxable at zero rate) are entitled to reclaim VAT paid on their inputs. - Businesses prepare a VAT return, which is submitted to Commissioner, VAT. - The most usual position is to have to pay the net balance to Commissioner, VAT (when output tax exceeds input tax), i.e., the amount owed to Commissioner, VAT is a payable. - A trader who makes zero-rated supplies will have paid more input tax than it has received output tax, so will be in a position to adjust with Commissioner, VAT. ### 8.4 Accounting for VAT - As a general principle, the treatment of VAT in the trader's ledger accounts should reflect the trader's role as tax collector, so VAT should not be included in income or in expenses, whether of a capital or a revenue nature. ### 8.4.1 Irrecoverable VAT - Where the trader suffers irrecoverable VAT as a cost, as in the following cases, VAT should be included as an expense (it cannot be claimed as input tax). - Traders not registered for VAT will suffer VAT on inputs as a cost. - This will increase their expenses and the cost of any non-current assets they purchase. - Registered traders who also carry on exempted activities may suffer VAT on certain inputs. - This will increase the expense in respect of these inputs. - Non-deductible inputs will be borne by all traders. - For example, VAT on cars purchased and used in the business is not reclaimable (VAT on a car acquired new for resale, i.e., by a car trader, is reclaimable). - VAT on business entertaining is not deductible as input tax other than VAT on entertaining staff. - Where VAT is not recoverable, it must be regarded as part of the cost of the items purchased and included in the statement of profit or loss or statement of financial position as appropriate. ### 8.5 VAT and Discounts - If a trade discount is given, VAT is charged on the sale amount, net of the trade discount. - If an early settlement discount is offered at the point of sale, output VAT is accounted for on the amount that is actually received from the customer. - As a result, customers can recover VAT only on the actual amount paid to the supplier. ### 8.6 VAT and Irrecoverable Debts - Most registered persons are obliged to record VAT when a supply is made or received (effectively when a sales invoice is raised or a purchase invoice recorded). - This may have the effect that output tax has to be paid to Commissioner, VAT before it has all been received from customers. - If an amount due from a customer is subsequently written off as irrecoverable, the VAT element may not be recoverable from Commissioner, VAT for some time after the sale. ### 8.7 Summary of Accounting Entries for VAT - Let us summarise how VAT is recorded in the nominal ledger accounts: 1) **Sales** shown in the statement of profit or loss must exclude output VAT. - However, trade receivables will include VAT, as they reflect the total amount due from customers. - The double entry for sales on credit of CU500, excluding VAT at 15% is: - **Journal** | Account to be Debited | Debit CU | Account to be Credited | Credit CU | |---|---|---|---| | Trade Receivables (including VAT, called gross) | 575 | Revenue (excluding VAT, called net)) | 500 | | | | VAT (15% x CU500) - output tax | 75 | 2) **Expenses** shown in the statement of profit or loss must exclude input VAT. - However, trade payables will include input VAT, as they reflect the total amount payable to suppliers. - The double entry for credit purchases of CU400, excluding VAT at 15%, is: - **Journal** | Account to be Debited | Debit CU | Account to be Credited | Credit CU | |---|---|---|---| | Purchases Expense (net) | 400 | VAT a/c (15% × CU400) - input tax | 60 | | | | Trade payables (gross) | 460 | 3) If sales were made or expenses were incurred in cash rather than on credit, the sales and expenses would be recorded excluding the VAT, and the cash amount would include VAT. 4) **Irrecoverable VAT** on expenses or non-current assets must be included in the cost of the expense or non-current asset in the statement of profit or loss or statement of financial position. 5) **The net amount due to** (or from) **Commissioner, VAT should be included in other payables** (or other receivables) **in the statement of financial position.** ### 8.8 Calculating VAT from a Gross Amount - If you are told that an amount includes VAT at 15% (a gross amount), you can calculate the VAT element by multiplying the gross amount by 15%/115%. **Context Example: VAT Calculation ** - A sale of CU200 attracts VAT at 15%, ie, CU30. - The gross amount is CU230. - To get back to the VAT element: - CU230 × 15/115 = CU30