The Value Added Tax (VAT) isn’t everyone’s favorite.
Public members know they pay taxes, but don’t think about how they are calculated. Working in accounts changes all that. Your work becomes dependent on knowing VAT rates, inclusive or exclusive figures, and how to calculate them accurately.
Throughout this article, two main calculations will be discussed that affect vatable figures.
- Using a net figure to calculate VAT
- Taking the VAT out of a gross figure
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The calculations are fundamentally different, yet we frequently confuse them, so before we look at how to calculate them, let’s consider what they actually mean.
We will stop getting confused if we understand them better.
To begin, let’s discuss terminology
How do gross and net differ? According to what I found online:
“A gross number refers to the entire amount of something, while a net number refers to a part of that amount after some type of deduction has been made. Net income is earnings after taxes, interest payments, expenses, overheads, and overheads have been deducted from gross income.
VAT calculations may be confusing due to the fact that net is defined as what is left over after deductions.
The remainder makes sense when considering net income, and it also works for net pay, where we begin with gross income and deduct taxes, national insurance, and pension contributions to arrive at net income.
When calculating VAT for a net purchase or sale figure, we don’t make deductions.
It’s the exact opposite from a practical standpoint. A percentage of the net amount is calculated as the VAT, then added to the net amount to arrive at the gross amount.
As we have had to add VAT during the calculation, the result is the same, since the net figure is the amount without the VAT.
As a result, when it comes to VAT calculations, it is easier to think of the net as what is left over after the VAT has been deducted.
In most cases, VAT is calculated this way during the preparation of sales invoices. The following are among them:
- Net sales value, the amount belonging to the business
- VAT, which is the responsibility of HMRC
- The total amount that the customer will pay on the invoice
Combining this understanding with the skills necessary to calculate percentages is the key to successfully calculating VAT on a net figure. For those who find percentages challenging, read this article first on percentages to get a better understanding.
Calculating VAT using a % table
VAT calculations will be made more accurate by using a % table.
There is a column for values, a column for percentages, and three component parts (net, VAT, and gross). As we don’t have all the information, we’ll have to work out the remaining percentages using our understanding of the relationships between the three components.
VAT is calculated on net figures by adding the VAT percent to the net amount.
For instance, we’re preparing a sales invoice for a sale worth £4,682, which is taxable at 20%.
The following four boxes can be filled out using the table and our understanding of VAT calculations:
The missing values can now be calculated. In order to calculate the gross, multiply the net by 1%, scale that up to 20%, and then add the VAT to the net.
Before we move on, let’s consider what these figures mean.
Calculation began with the net amount, which is a VAT-exclusive figure since VAT is not included in the net amount. Our next step was to calculate how much VAT was owed by taking 20% of it.
In order to determine the gross amount, the net amount was added to the VAT amount. A customer’s invoice total is shown here.
VAT has now been included in the gross amount, so it is now a VAT inclusive figure.
Taking a gross figure and extracting the VAT
The next step is to extract VAT from a gross or inclusive figure.
It is a fundamentally different calculation to extract VAT from a gross figure, because now we’re starting with both the net and VAT percentage, or 120%.
In this instance, we are assuming that the company is VAT registered and making standard rated vatable supplies (20% at the time of writing).
When we’re checking invoices we’ve received from suppliers, we’re usually dealing with VAT inclusive figures.
In this example, let’s assume that we received a purchase invoice for £669.60.
This would complete the % table as follows:
Calculations now follow a different order and reflect the notion that gross is the “whole” and net is a “part of that whole.”.
To ensure the figures look reasonable, we can use gross and net definitions to check our calculations.
It does not matter if VAT is calculated from net figures or extracted from gross figures, since VAT is a percentage added to the net.
It is reasonable to assume that the invoice total will be greater than the net sales or net purchases since VAT is paid by the end consumer.