Monday, 14 September 2020

DOUBLE ENTRY FOR BEGINNERS - PART 2

 DOUBLE ENTRY FOR BEGINNERS - PART 2 

SALES SCENARIOS- PART 2

 

Financial Accounts are built on the double entry principle which states that:

 

FOR EVERY DEBIT ENTRY, THERE MUST BE A CORRESPONDING CREDIT ENTRY;

 

So, in posting any transaction into your accounts, you always need to identify which account needs to be debited and which account needs to be credited.

 

A common acronym used to learn the double entry is DEAD/ CLIC

 

DEAD                                                                    CLIC

Debit: Expenses, Assets, Drawings                  Credit: Liabilities, Income, Capital

 

DEBIT TRANSACTIONS                                      CREDIT TRANSACTIONS

 

If any of these are increasing,                             If any of these are increasing,

you will need to debit the account                     you will need to credit the account

and vice versa, if it is decreasing                       and vice versa, if it is decreasing

 

 

Let’s introduce VAT to the previous scenarios:

 

VAT is tax on commodities and the VAT on sales is a liability to companies, because it is collected from customers and paid to the government and VAT on purchases is an asset because it can be claimed back by VAT registered businesses. This means that a VAT registered business must charge VAT on its sales and this is payable to the government and it can reduce this liability by any VAT it may have paid, i.e. VAT on purchases. VAT is currently charged at 20% standardly. (Please note that this statement has been kept to the simple basics).

 

 

1. If a customer buys products worth £230 net from you and doesn’t pay immediately, i.e. credit sale. In such situation, a sale has taken place, you will have to pay VAT on the sale and a debtor has been established since the customer owes you the full amount. Invariably, sales have increased, as you have sold products; VAT liability has increased, as you owe the government; and debtors (asset) has also increased.

 

 

Net amount                                                   £230.00

VAT amount (20% x £230)                            £46.00

Gross amount (total amount owed)              £276.00

 

 

 

                                                Accounts affected


 


                            Sales                      VAT                  Debtors

 


Double entry posting will then be:

 

Dr- Debtors (asset)                                       £276

Cr- VAT (liability)                                           £46

Cr- Sales (income)                                        £230

 

 

In this case, you have sold products worth £230, and you will charge 20% for VAT, which amounts to £46. The customer doesn’t have a choice but to pay the full amount of £276 and then you have to pay the government the £46 of VAT, so, £230 will be your income and not £276. Hence, the VAT on sales is a liability which is payable to the government if the business is VAT registered. VAT is always accounted for in the Balance Sheet as an asset or a liability and not in the Profit & Loss account.

 

 

 

2. If a customer buys products worth £230 net from you and pays immediately, i.e. cash sale. In such situation, a sale has taken place, you will have to pay VAT on the sale and cash has increased since the customer has paid you money. Invariably, sales have increased, as you have sold products; VAT liability has increased, as you owe HMRC; and cash (asset) has also increased.

                                   

 

                                                Accounts affected


 


                            Sales                      VAT                      Cash

                       

 

Double entry posting will then be:

 

Dr- Cash (asset)                                           £276

Cr- VAT (liability)                                           £46

Cr- Sales (income)                                        £230

 

 

In every business, there are always financial transactions which lead to financial documents which need to be posted into the accounts.

 

 

When a sale is generated, there should always be the question as to what type of income was generated and was this paid immediately or not. The sales should be credited with the net amount, the VAT should be credited with the VAT amount and the debtors should be debited if payment hasn’t been made or the cash/ bank will be debited if payment has been made immediately.

 

 

For credit sales, when payment is later made, the double entry posting will be;

Dr- Cash/ Bank

Cr- Debtors

 

 

In this case, debtors account (which is an asset under DEAD) is reducing, so it is credited and cash (which is also an asset under DEAD) is increasing, so it is debited.

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