Financial Accounting · Sales and purchases

Sales Tax (VAT) on Sales and Purchases Explained

Updated 11 October 2026 · Fact-checked

Sales tax (VAT) is a tax collected by your business for the tax authority. Output tax on sales is a liability. Input tax on purchases is deducted from it. Record sales and purchases net of tax, post the tax to the sales tax account, and the balance is owed to or recoverable from the authority.

Understand Sales Tax (VAT) on Sales and Purchases

Sales tax is a tax on the value added at each stage of the supply chain. Your business does not bear it. You collect it from customers and pay it over to the tax authority. This is why it never counts as your income or expense.

Output tax is the tax you charge on your sales. It is money you owe to the tax authority, so it is a credit in the sales tax account. Input tax is the tax you pay on your purchases and expenses. You can usually reclaim it, so it is a debit in the sales tax account.

The sales tax account is a running account. Credits are output tax. Debits are input tax. If credits are bigger, the balance is a liability: you owe the authority. If debits are bigger, the balance is an asset: the authority owes you a refund.

The key habit is to split every invoice into net, tax and gross. Sales and purchases are recorded at the net amount. Receivables and payables are recorded at the gross amount, because that is what the customer owes you or you owe the supplier. Cash sales work the same way, with cash replacing receivables.

Some items do not allow input tax recovery, such as certain expenses a question says are irrecoverable. In that case the tax is part of the cost of the item. Exempt supplies and zero-rated supplies are different: zero-rated sales carry tax at 0% but still allow input tax recovery. Always follow the facts given in the question.

Key formulas to remember

Tax on a net amount: Sales tax = Net amount × tax rate; Use when the invoice amount is stated excluding tax.
Net to gross: Gross = Net × (1 + rate); For a 20% rate, Gross = Net × 1.2.
Gross to net: Net = Gross ÷ (1 + rate); Tax = Gross − Net, or Gross × rate ÷ (1 + rate). With a 20% rate, tax is 1/6 of gross.
Credit sale entry: Dr Receivables (gross); Cr Sales (net); Cr Sales tax (tax); Output tax is a liability to the authority.
Credit purchase entry: Dr Purchases (net); Dr Sales tax (tax); Cr Payables (gross); Input tax is recoverable, so it is debited to the sales tax account.
Sales tax account balance: Output tax (credits) − Input tax (debits); Positive means a liability owed. Negative means a receivable recoverable.
Payment to authority: Dr Sales tax; Cr Bank; Clears the liability. A refund received is Dr Bank; Cr Sales tax.

How to solve Sales Tax (VAT) on Sales and Purchases questions

Use this method for any sales tax question, whether it asks for journals, ledger balances or a figure for the financial statements.

1Read the question and note the tax rate and whether each amount is stated net or gross.
2Convert every amount to net, tax and gross. Divide by (1 + rate) if you are given gross.
3Check for irrecoverable input tax. If a question says tax cannot be reclaimed, add it to the cost of the item.
4Write the entries: sales and purchases at net, receivables and payables at gross, tax to the sales tax account.
5Total the credits (output tax) and debits (input tax) in the sales tax account, including any opening balance.
6Find the balance and say whether it is owed to or recoverable from the authority.
7Show it in the statement of financial position: a liability under current liabilities, or a receivable under current assets.
8Check that total debits equal total credits in your entries.

Quickest way: Net, tax, gross in one line

When to use it: Use this for multiple-choice and number-entry questions where you only need a balance or a single figure.

Total all net sales and multiply by the rate to get output tax.
Total all net purchases and recoverable expenses and multiply by the rate to get input tax.
Subtract input from output, adding any opening liability.
If the answer is positive, it is payable. If negative, it is recoverable.
If given gross figures at 20%, take one sixth of gross as the tax. Adjust the fraction for other rates: rate ÷ (100 + rate).

Common mistakes in Sales Tax (VAT) on Sales and Purchases

Recording sales or purchases at the gross amount.
The invoice total is the most visible number, so students use it for everything.
Fix: Post only the net amount to sales or purchases. Gross goes to receivables or payables.
Treating sales tax as income or an expense.
Students forget the business only collects the tax on behalf of the authority.
Fix: Put all recoverable tax in the sales tax account only. It never reaches profit or loss.
Calculating tax on a gross figure by multiplying by the rate.
Students apply 20% to the total instead of removing tax from it.
Fix: Divide gross by 1.2 to find net, or multiply gross by 20 ÷ 120. Check that net plus tax equals gross.
Reversing the balance direction, calling a credit balance an asset.
Students mix up input and output tax debit and credit sides.
Fix: Remember output is owed, so credit. Input is reclaimed, so debit. Credit balance is a liability.
Reclaiming tax that the question says is irrecoverable.
Students apply the standard rule without reading the facts.
Fix: If tax cannot be reclaimed, include it in the cost of the asset or expense and do not debit the sales tax account.
Ignoring the opening balance in the sales tax account.
Students focus on current-period transactions only.
Fix: Start the account with the brought-forward balance and clear it with payments made to the authority.

Worked examples

Example 1

A business sells goods on credit for $4,000 excluding sales tax. It buys goods on credit for $2,500 excluding sales tax. The sales tax rate is 20%. Show the entries and the balance on the sales tax account.

Show the solution

Output tax on sales: $4,000 × 20% = $800. Gross sale = $4,800.
Input tax on purchases: $2,500 × 20% = $500. Gross purchase = $3,000.
Sale entry: Dr Receivables $4,800; Cr Sales $4,000; Cr Sales tax $800.
Purchase entry: Dr Purchases $2,500; Dr Sales tax $500; Cr Payables $3,000.
Sales tax account: credit $800, debit $500. Balance = $800 − $500 = $300 credit.

Answer: The sales tax account has a credit balance of $300. This is a liability owed to the tax authority.

Example 2

At the start of the month, a business owes $1,200 sales tax. During the month, cash sales including tax total $9,600 and credit purchases including tax total $5,400. The rate is 20%. It pays $1,200 to the authority. Find the closing balance.

Show the solution

Tax in cash sales: $9,600 × 20 ÷ 120 = $1,600 (net sales $8,000).
Tax in purchases: $5,400 × 20 ÷ 120 = $900 (net purchases $4,500).
Opening balance credit $1,200. Add output tax credit $1,600. Total credits = $2,800.
Debits: input tax $900 and payment $1,200 = $2,100.
Closing balance = $2,800 − $2,100 = $700 credit.

Answer: The closing balance is $700 credit, so the business owes $700 to the tax authority and shows it as a current liability.

Exam tips

Write net, tax and gross in a quick column for every invoice before you answer. It stops most slips.
In multiple response questions, check which entries involve the sales tax account and whether each is a debit or credit.
For number entry, give the figure only, in the unit asked. State whether it is payable or recoverable only if the question asks.
Look for words like irrecoverable, exempt or zero-rated. They change the treatment, so read them twice.
Section B questions may include sales tax inside ledger or control account work. Strip tax out before posting to sales or purchases.

Practice questions from Sales and purchases

Sales Tax (VAT) on Sales and Purchases in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

ACCA Applied SkillsTests of Controls for Sales, Purchases and Payroll Cycles

Sales Tax (VAT) on Sales and Purchases: frequently asked questions

What is the difference between input tax and output tax?

Output tax is the tax you charge customers on your sales. Input tax is the tax you pay suppliers on purchases and expenses. You pay the authority the difference, output minus input.

Is sales tax an expense for the business?

No, not when it is recoverable. The business collects it for the tax authority and records it in the sales tax account. Only irrecoverable tax becomes part of the cost of an item.

How do I know if the sales tax account is an asset or a liability?

Look at the balance. A credit balance means output tax exceeds input tax, so you owe the authority and it is a liability. A debit balance means you are owed a refund and it is a receivable.

What is the journal entry for a credit sale with sales tax?

Debit receivables with the gross amount. Credit sales with the net amount. Credit the sales tax account with the tax. The debit equals the two credits combined.