Unit 5: VAT and TAX

1. Explain the nature and treatment of VAT.

2. Explain the nature and treatment of INCOME TAX.

Introduction

Moment 0 Moment 1

ACTIVITY DEVELOPMENT
Setting up of a At the end of
company period and make
ECONOMIC AND FINANCIAL a profit
TRANSACTIONS DURING A PERIOD OF
TIME

Generate applications
and origins of resources
continuously
Goods and
Obligations Goods and
Right Obligations
Right

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 The Accounting Cycle

PHASES IN THE ACCOUNTING CYCLE

• Opening
Opening entry
• During the period
Journalising
The Trial Balance
• Closing
Adjusting Process
Closing Process
• Prepare Financial Statements
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Treatment and incidence of the TAX liability

Ø Valued Added TAX

Ø Income TAX

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 Value- Added TAX (VAT)

VAT (Value-added TAX) is a TAX that weighs on the final

consumer. Every VAT subject must calculate and
periodically deposit the TAX to the Revenues Authority.

Every country has its own VAT rates that are established
in different percentages depending on the type of
merchandise or service. Certain merchandise and
services are exempt or excluded.

The percentages vary according to the financial necessity

of the country; therefore, there can be changes in the
years.

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Value- Added TAX (VAT)

Three rates applicable for different products (SPAIN):

- Reduced rate 4% (to promote specific economic
activities)
- Products and services covering basic needs 10%
- Regular VAT 21%

VAT applies to:

- Sales of goods and services by businesses or individual
professionals
- Purchases of goods or services within the EU Imports

There are certain activities exempt from VAT (education,

medical services, cultural activities, sports events, etc.)

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 Value- Added TAX (VAT)

Companies just collect VAT, consumers pay it.

VAT (payable) is collected by companies from purchasers of their goods or

services, along with sales revenue.

VAT (receivable) is paid to suppliers of good or services together with the

acquisition cost (also in advance payments)

VAT is periodically settled, i.e., remitted to state government agencies (in

Spain, Agencia Estatal de la Administración Tributaria, AEAT)
Spanish companies must settle VAT periodically (monthly or quarterly,
depending on their size).

Form 300 must be filled out submitted electronically or handed in at an

AEAT office.

At the end of the fiscal year, companies must fill out form 390, with a
summary of all VAT-related transactions.
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Value- Added TAX (VAT)

On 01/01/22, the company A, Ltd. purchases on account a car for

12,000 Euros (VAT 21%). The activity of the company is to buy and
sell cars.

What journal entries should the company A, Ltd. make to account for
VAT under Spanish standards?

DATE Accounts DEBIT CREDIT

01/01/2022 Merchandise Purchased 12,000
Input VAT 2,520
Suppliers 14,520

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 Value- Added TAX (VAT)

The car is sold two weeks later at 15,000 Euros. VAT is 21%.

What journal entries should the company A, Ltd. make to account for
VAT under Spanish standards?

DATE Accounts DEBIT CREDIT

15/01/2022 Bank 18,150
Merchandise sold 15,000
Output VAT 3,150

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Value- Added TAX (VAT)

On 01/02/2022, the company A, Ltd. purchases two cars at 25,000

Euros (VAT: 21%). The activity of the company is to buy and sell cars.

What journal entries should the company A, Ltd. make to account for
VAT under Spanish standards?

DATE Accounts DEBIT CREDIT

01/02/2022 Merchandise Purchased 25,000
Input VAT 5,250
Suppliers 30,250

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 Value- Added TAX (VAT)

One car is sold two weeks later at 20,000 Euros. VAT is 21%

What journal entries should the company A, Ltd. make to account for
VAT under Spanish standards?

DATE Accounts DEBIT CREDIT

15/02/2022 Bank 24,200
Merchandise sold 20,000
Output VAT 4,200

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Value- Added TAX (VAT)

DATE Accounts DEBIT CREDIT

31/03/2022 Output VAT 7,350
Input VAT 7,770
VAT Recoverable 420

The company may request payment of VAT recoverable from AEAT

or either reduce future VAT payable in that amount. Companies
have 5 years to compensate VAT recoverable with VAT payable.

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 Value- Added TAX (VAT)

VAT collection gives rise to a liability (an obligation to disburse cash in

the future to settle VAT, Account: Output VAT).

VAT payments are recognized as an asset (a right to receive cash

back from the TAX authority, AEAT, Account: Input VAT).

On the balance sheet date, output VAT (over the last month or
quarter) is compared with input VAT.

If the former is greater, the company must record the net VAT balance
as a liability in the balance sheet, until the settlement date (Account:
VAT payable).

If input VAT is greater than output VAT, the company has a right to
receive cash back from AEAT. Therefore, an asset is recognized for
the positive net VAT balance. (Account: VAT recoverable).

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Income TAX

TAX rates on corporate Taxable income differ greatly around the world, and they change
from year to year. The amount of corporate income TAX payable by a company is
calculated by multiplying the Taxable income by the TAX rate.

Accounting Income
There may be
differences between
the two amounts
=
Taxable income

Permanent
Differences

Temporary
Differences

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7
 Income TAX
Payments on
Accounts

It made three payments of TAX during the year:

ü Dates: 20 April, October and December
ü Amount: Depending on the type of business there are alternatives. For example, a
fixed percentage on the last TAX assessment or the outcome of the current year.

DATE Accounts DEBIT CREDIT

20/ April, October, Withholdings and payments on account
X
December to TAX
Bank X

Ø Record the Current TAX

DATE Accounts DEBIT CREDIT
31/12/X Current TAX (Expense) X
Recoverable taxes X
Income tax payable X
Withholdings and payments on account to TAX X

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Income TAX

PAYMENTS ON ACCOUNT
Of Income TAX for the year X2
PAYMENTS ON ACCOUNT
of Income TAX for the year X1

20/04/X1 20/10/X1 20/12/X1 20/04/X2 20/10/X2

25/07/X2
01/01/X1 31/03/X1 30/06/X1 31/09/X1 31/12/X1
31/03/X2 30/06/X2 30/09/X2

SETTLEMENT AND
ACCOUNTING OF THE PAYMENT
of the TAX for the year X1
EXPENSE (INCOME) FOR THE
TAX OF THE YEAR

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 Example

A company that is taxed at 25%, makes a profit before TAX (which coincides with
the TAX base) 1,000,000 Euros.

Determine and record the income TAX, to 31/12/22, bearing in mind that has made
payments to account during the year for a total of 65,000 Euros. The TAX payment
will be made in July 2023.

DATE Accounts DEBIT CREDIT

31/12/22 Current TAX 250,000
Income tax payable 185,000
Withholdings and payments on account to TAX 65,000

DATE Accounts DEBIT CREDIT

25/07/23 Income tax payable 185,000
Bank 185,000

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