AP2 - accounting equation question (stuck)

Kashcow wrote: »

Hi,
I was doing the mock CBT on the website and was slightly confused by the task 1.2 question e.

A business has a large debit balance in its cash book. It's VAT control account always shows tax on sales greater than tax or purchases.
The quarterly VAT account is settled by means of an automated bank transaction.
What effect des this have on: Assets, Liabilities, Capital?

Could anyone help break this down?
Thanks

Hi Kashkow

The cash book has a debit balance so this is your Asset.

The VAT account has more sales tax than purchase tax, so more sales = more VAT that you have to pay to HMRC. So your VAT account will have a credit balance and will be your Liability.

Every quarter the VAT is paid directly from the bank account.

So your Asset (the cash book) will decrease because you are paying money out.

Your Liability (the VAT account) will also decrease as you have paid this amount.

Capital will remain the same.


The double entry will be a credit to your bank (thus reducing the asset) and a debit to the VAT account (thus reducing the liability.)

Hope this makes sense.

A good technique is to try answering this type of question by using made up figures

E.g. Imagine that the Assets are £1000 and liabilities are £500.

If you deduct an imaginary payment to HMRC of £400 from the bank, what happens to the Liability:

Asset Bank reduces by £400 as does the HMRC Liability

What effect does all this have on Capital?

Before: Assets-Liabilities = Capital or £1000 - £500 = £500

After: Assets-Liabilities = Capital or £600 - £100 = £500

I hope this helps you answer similar questions - note, this can also be done to work out the effect on profit of a rise or fall of opening and/or closing stock or rise or fall in expenditure.

Word of caution - never make these things too complex as your time in the assessment is precious. As I tell my students - Keep it simple!

Good luck.