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| Value Added Tax(VAT) |
What is value added Tax(VAT)?-with Practical Examples:
VAT stands for Value Added Tax. It's a type of consumption tax that is levied on the value added to goods and services at each stage of their production and distribution. Essentially, each business in the supply chain pays VAT on the value they add to the product or service, and they can usually reclaim any VAT they've already paid on their own purchases. The final consumer ultimately bears the total cost of the VAT
Here's a Key Aspect of VAT:
Indirect Tax: Unlike income tax, which is a direct tax on earnings, VAT is an indirect tax because it's collected by intermediaries (businesses) but paid by the final consumer.
VAT is a multi-stage tax, meaning it's applied at each point in the supply chain, starting from raw material extraction and continuing until the final consumer purchase. Importantly, VAT is levied only on the "value added" at each stage – the difference between a business's sales revenue and the cost of its inputs. Input Tax Credit: Businesses that pay VAT on their purchases (inputs) can usually claim this back as a credit against the VAT they collect on their sales (outputs). This mechanism ensures that the tax is ultimately only on the final consumption.
Final Consumer Pays: The final consumer cannot reclaim the VAT they pay, so they bear the full burden of the tax.
Practical Example:1
Stage 1: Mr.X Rahman
X Rahman buys a saw for their business: Let's say the saw costs $100 + $10 VAT (10% of $100). X Rahman pays $110. The saw's supplier then sends that $10 VAT directly to the government."
X Rahman cuts trees and sells raw timber to a Carpenter: X Rahman adds value by felling the trees. They sell the timber for $50.
Output VAT collected by X Rahman: 10% of $50 = $5
Input VAT paid by X Rahman (on saw): $10 (this is an expense, so it's accounted for later)
X Rahman VAT to remit to government: $5 (collected from carpenter) - $0 (no direct input VAT on the timber itself in this step, but they'd offset VAT on other business expenses)
For simplicity, let's assume the X Rahman only charges VAT on the timber for this example. The actual VAT remittance is more complex as they'd net off all input VAT.
X Rahman sells timber for $50 + $5 VAT = $55.
Stage 2: The Carpenter
Carpenter buys timber from X Rahman: Pays $55 ($50 for timber + $5 VAT).
Carpenter builds a chair from the timber: Adds value through labor, skill, and other materials. They sell the finished chair to a Retailer for $120.
Output VAT collected by Carpenter: 10% of $120 = $12
For the timber, the carpenter incurred $5 in Input VAT.
Carpenter's VAT to remit to government: $12 (collected from retailer) - $5 (paid to logger) = $7
Carpenter sells chair for $120 + $12 VAT = $132.
Stage 3: The Furniture Retailer
Retailer buys the chair from Carpenter: Pays $132 ($120 for chair + $12 VAT).
Retailer sells the chair to the Final Consumer: Adds value by providing a sales space, marketing, and customer service. They sell the chair for $200.
Output VAT collected by Retailer: 10% of $200 = $20
Input VAT paid by Retailer (on chair): $12
"The retailer's net VAT payable to the government is $8 ($20 in output VAT collected from the consumer, less $12 in input VAT paid to the carpenter).
Retailer sells chair for $200 + $20 VAT = $220.
Summary of VAT Paid to Government:
X Rahman (on timber): $5
Carpenter (on value added): $7
Retailer (on value added): $8
Total VAT collected by government: $5 + $7 + $8 = $20
Notice that the total VAT collected by the government ($20) is exactly 10% of the final selling price to the consumer ($200). The consumer ultimately bears the entire tax burden of $20, even though it was collected in increments along the supply chain. So, every business in the chain just sends the government the VAT that corresponds to the value they contributed. They also get a refund or offset for any VAT they previously paid on what they bought."
Practical Example:2
The following Information has been taken from the accounting records of wimax company LTD. for the year 2025.
Raw Materials Inventory, January 1 = Tk.55,000
Raw Materials Inventory, December 31 = Tk.30,000
Work in process Inventory (WIP), January 1=TK.90,000
Work in process Inventory (WIP), December 31 = Tk.50,000
Finished goods inventory. January 1=TK.1,30,000
Finished goods inventory, December 31 = Tk.1,05,000
Purchase of raw materials =Tk.3,75,000
Direct labor =Tk.75,000
Manufacturing Overhead=Tk.3,20,000
Selling expense Tk.70,000
Administration Expense=Tk.1,35,000
The company sells its product by adding 20% profit on cost.
Requirement:
1.Determine the Amount of VAT if the rate is 15%.
**Try yourself the problem**