Study tips: how to calculate VAT

Let’s be honest nobody is a fan of Value Added Tax (VAT).

As members of the public, we know that we pay it but we don’t think about how it’s been calculated. All changes when you work in accounts. Suddenly VAT rates, knowing whether figures are inclusive or exclusive and how to calculate them accurately becomes vital to your work.

This article is going to concentrate on two main calculations that affect vatable figures.

  1. Calculating the VAT on a net figure
  2. Extracting the VAT from a gross figure

These are fundamentally different calculations yet ones we regularly mix up therefore we’re going to think about what they actually mean before we look at how to calculate them. If we understand them better we’ll stop getting them confused.

Let’s start with terminology

What is the difference between gross and net? When I searched online I found this explanation:

Gross refers to the whole of something, while net refers to a part of a whole following some sort of deduction. For example, net income for a business is the income made after all expenses, overheads, taxes, and interest payments are deducted from the gross income.*

The fact that most definitions of  net refer to what’s left over after deductions, may be the source of confusion when it comes to VAT calculations.

What’s left over makes sense in relation to the example of net income and also works for net pay; where we start with a gross figure and deduct tax, national insurance, pension contributions and the like, to arrive at the net amount we actually receive.

However, making deductions isn’t what we do when we calculate VAT for a net sales or purchases figure. From a practical point of view we do the exact opposite. We calculate the VAT as a percentage of the net figure and then add it onto the net amount to arrive at the gross. The result is the same because the net figure is the amount without the VAT but the starting point is different as we’ve had to add the VAT during the calculation.

So, in terms of VAT calculations it’s easier to think of the net as the amount before the VAT has been added.

If we think about when we calculate VAT in this way it is usually when preparing sales invoices. These include:

  • the net value of the sale, the amount that belongs to the business**
  • the VAT, which belongs to HMRC
  • the gross amount or invoice total that will be paid by the customer

To successfully calculate the VAT on a net figure we need to combine this understanding with the skills needed to calculate percentages. This can be a tricky area too, so if you find it difficult have a read of this article on percentages first.

We’re going to use a % table to help accurately perform VAT calculations.  It has the three component parts (net, VAT & gross), a column for values and a column for percentages. We won’t have all the information needed to complete it so we’ll need to use our understanding of the relationships between the three components, and percentages to work out the rest.

vat 123

When calculating the VAT on a net figure the net amount represents 100% and the VAT % is added to calculate the gross.

Let’s imagine we’ve made a sale worth £4,682, which is vatable at 20% and we’re preparing the figures for the sales invoice.

Using the table we can complete four of the boxes with figures we have and our understanding of VAT calculations:

vat576

Now we can calculate the missing values. The easiest method is to calculate 1% first, scale that up to 20% to calculate the VAT, then add the VAT to the net to calculate the gross.

76475 vat

Let’s think about what these figures mean before we go on. We started the calculation with the net amount which doesn’t include the VAT so is a VAT exclusive figure. We then calculated 20% of it to tell us how much VAT was chargeable. By adding the net and the VAT we calculated the gross amount. This is the invoice total that the customer will pay. The gross amount now includes VAT so it’s a VAT inclusive figure.

Now let’s look at extracting VAT from a gross/inclusive figure.

Whilst all the definitions stay the same, the calculation for extracting VAT from a gross figure is fundamentally different as now we’re starting from a figure that represent both the 100% net and the VAT % i.e. 120% **

**Assuming this is a VAT registered business making standard rated vatable supplies (20% at the time of writing).

Dealing with VAT inclusive figures is usually part of the purchase process when we are checking invoices we have received from suppliers.

Let’s suppose we received a purchase invoice for £669.60 inclusive.

The % table would be completed as:

v1a1t

The calculations now just work in a different order and fit the definition of the gross being the ‘whole’ and the net being ‘part of that whole’ after the deduction of VAT.

v2vat

Once we understand the definitions of gross and net we can use them to check our calculations and ensure the figures look reasonable.

As VAT is a percentage added to the net, the gross should always be more than 100% regardless of whether the VAT is being calculated from a net figure or extracted from a gross figure. As the end consumer suffers the VAT, it is reasonable to always expect that the invoice total will be more than the net sales or net purchases.

Gill Myers has taught AAT qualifications since 2005.

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