Today I was doing math homework with my son, who is in 7th grade. The math problems reminded me that I meant to post about calculating VAT.
In business-to-business sales, VAT is typically added to (on top of) the agreed price. The calculation would go like this:
Agreed price $250
VAT (20%) $50
However, in business-to-consumer sales, VAT is often included in the agreed price. Moreover, most consumer protection laws stipulate that tax must be included in advertised amounts, so that the consumer pays exactly the advertised price at the register. This is quite different from collecting sales tax here in the U.S., where sales taxes only materialize at the register. If you buy the newest Go-Pro camera here in NYC, as widely advertised, for $299, you end up paying something like $325.16. Crazy. And frustrating. But I digress.
In the VAT world, sales to consumers are tax inclusive. So, how do we extract the VAT out of the end price? Here is where the math comes in.
Agreed price: $300, VAT is 20%
VAT is 20/120 * $300 = $50
Net price is 100/120 * $300 = $250
I have seen so many seasoned accountants struggle with this 7th grade math problem, that I felt the need to include the solution here.
A respectful hat-tip to all teachers out there. In particular to my son’s math teacher, Laura Badolato, who inspires an entire family of math-challenged Houtzagers.