VAT: input and output tax

Value added tax is charged at every stage of the supply chain, but each business pays over only the tax on the value it adds. It does this by netting two amounts each return period:

• Output VAT — VAT the business charges its customers on taxable sales. Credit VAT payable (output VAT).
• Input VAT — VAT the business pays its suppliers on purchases used for taxable sales. Debit Input VAT recoverable.

At the end of the period the business files a VAT return: output VAT less recoverable input VAT. A positive balance is paid to the tax authority; a negative balance is a refund or a credit carried forward. The return is a settlement of balances — it has no effect on profit.

Tax-exclusive vs tax-inclusive prices. If a price is quoted before VAT, VAT = net × rate. If a price includes VAT (common in retail), VAT = gross × rate ÷ (1 + rate). At 15%, that is 15/115 of the gross — not 15% of it.

Timing. VAT is due on the invoice (or on the earlier of invoice, payment and delivery under many systems) — not when cash is received. That's why a credit sale creates output VAT immediately, and a supplier invoice creates input VAT before you have paid it.

Cost of inventory and assets. Recoverable input VAT is not part of cost. Inventory bought for 8,000 plus 1,200 VAT costs 8,000; the 1,200 is a claim against the tax authority. Including it in inventory overstates cost of sales later and double-counts the VAT when you also reclaim it.

A 15% rate is used in these examples and exercises as an illustrative assumption; actual rates depend on the jurisdiction and change over time. The mechanics are the same at any rate.