What is Value Added Tax (VAT)?

Published

April 22, 2026

Last updated

April 22, 2026

Definition

Value Added Tax (VAT) is a consumption tax levied on a product or service whenever value is added at each stage of production and distribution. Unlike a direct sales tax, VAT is collected incrementally throughout the supply chain. The final consumer ultimately bears the full tax burden, but businesses act as collection agents for the government at each transaction point.

For a business, managing VAT involves charging it on sales (output VAT) and paying it on purchases of goods and services (input VAT). The company then remits the difference between the output and input VAT to the tax authorities. This process directly impacts the Cash Flow Statement, pricing strategies, and requires meticulous record-keeping for accurate financial reporting.

Proper accounting for VAT is crucial for compliance and financial health. It necessitates separate tracking within the Chart of Accounts (COA) to distinguish tax liabilities and recoverable amounts from core business revenue and expenses.

Related terms

Accounts Payable (AP)

Accounts Receivable (AR)

Free Cash Flow (FCF)

Frequently Asked Questions

What is the difference between sales tax and VAT?

VAT is collected at every stage of the supply chain where value is added, whereas sales tax is collected only once, at the final point of sale to the consumer. Businesses can generally reclaim the VAT they pay on inputs, which is not the case for sales tax.

How does VAT work in accounting?

In accounting, businesses record VAT collected on sales as a liability (VAT Payable) and VAT paid on purchases as an asset (VAT Recoverable) on the balance sheet. The net balance determines the payment to or refund from tax authorities, which keeps the tax separate from company revenue and expenses.