If the business is cash accounting for VAT, when the business raises a sales invoice, the VAT element can’t yet go to code 819 VAT Charged, because that’s what populates box 1 on the VAT return - and the output VAT on this invoice shouldn’t go on to the VAT return until the customer pays the invoice.
So FreeAgent takes the VAT element of the invoice as a credit to code 823, Deferred VAT.
When the user enters a receipt against that invoice (an Invoice Receipt bank transaction), you may remember that FreeAgent posts the entries for that receipt as Debit Bank, Credit Trade Debtors.
But FreeAgent does something else as well when the business is cash accounting and the user records an invoice receipt, which is to post a pair of automatic journal entries to move the VAT element of the invoice from code 823 Deferred VAT to code 819 VAT Charged.
Those entries will debit code 823 (to reduce the amount of liability in there), and credit code 819 (to increase the amount owed to HMRC).
Let's see that happening in 'Show Transactions' in the app.
You’ll see that for the invoice receipt, because the business is cash accounting, four entries have been created. The total amount of the receipt, £1,200, has been posted to reduce the amount owed by customers (Trade Debtors) and increase the amount in the bank account. The VAT amount on the receipt, £200, has been moved to code 819 VAT Charged, so that it appears on the VAT return now that the invoice has been paid.
For bills and bill payments when the business is cash accounting, exactly the same thing happens, only the entries will be the opposite way round in terms of debits and credits.
When the user creates a bill, the amount of input VAT that will be reclaimable once the bill has been paid goes to code 823 Deferred VAT, because the input VAT can’t be reclaimed until the bill has been paid when the business is cash accounting.
When a bill payment is put against that bill by the user, FreeAgent posts the full amount of the bill payment as a debit to Trade Creditors, to reduce the amount that the business owes to its suppliers, and a credit to the bank account, to reduce the amount that the business has in the bank because it has spent some on paying this bill.
But it also automatically posts journal entries to move the amount of VAT from code 823 to code 818, now that the VAT can be reclaimed.
Here’s what that looks like in 'Show Transactions' in the app.