Standards in practice: GRAP 104
The VAT in your consumer debtors is part of the receivable, and it has to be impaired with it
Many municipalities still impair the VAT-exclusive balance and carry the VAT as if it were already SARS's money. The ASB Secretariat's Fact Sheet 11 points the other way, and the difference is not small.
Here is a question that comes up in almost every impairment review we do. A household owes the municipality R1 150 for water, made up of R1 000 for the service and R150 of VAT. The account is 200 days old and the provision matrix says 70 percent of it will never be collected. Do you impair R1 150 or R1 000?
A surprising number of municipalities impair R1 000. The reasoning goes that the R150 belongs to SARS, so it is not really the municipality's asset and should not be impaired. Some go a step further and net the VAT on outstanding debtors against the receivable, so the balance sheet shows debtors excluding VAT. Both treatments are wrong under GRAP 104. The starting point is Fact Sheet 11 on the classification of VAT, issued by the Secretariat of the Accounting Standards Board, which settles the classification question that the impairment answer follows from.
What Fact Sheet 11 actually says
The fact sheet looks at the whole transaction, not just the service portion. When a municipality supplies water or electricity to a customer, the amount the customer owes arises from the contract between the two of them, and that amount includes the VAT. In the fact sheet's words, the entire transaction, including the VAT component, is classified as a contractual receivable. A contractual receivable is a financial asset, and financial assets fall under GRAP 104. So the R1 150 is one receivable, it is a financial instrument, and the expected credit loss requirements apply to all of it.
The fact sheet then draws the line that many municipalities have been drawing in the wrong place. The obligation to pay VAT to SARS arises from legislation, not from the contract with the customer, so it is a statutory arrangement and is not a financial instrument. The customer's debt and the municipality's obligation to SARS are two different things, measured on two different bases, and they should not be netted against each other.
One caution on status: the fact sheet is guidance prepared by the ASB Secretariat to help preparers apply GRAP 104 and GRAP 108, not a Standard in its own right. It is, however, the reference the AGSA relies on, and in our experience it is applied as written.
Why the answer is R1 150
Expected credit losses are measured on the cash flows the municipality is contractually entitled to receive, less the cash flows it expects to receive. The customer owes R1 150. If the municipality expects to collect 30 percent of that, the shortfall is 70 percent of R1 150, which is R805, not R700. The VAT on the uncollectable portion is money the municipality will never receive, and a receivable that will never be received is impaired, whatever the money was going to be used for once it arrived.
Impairing only the VAT-exclusive amount overstates the receivable by the VAT on the expected loss. Across a debtors book of a few hundred million rand that difference is usually material, and it is one of the easier findings for an auditor to raise because the arithmetic is on the face of the age analysis.
What happens to the VAT side
This is where the treatment depends on how the municipality accounts for VAT with SARS. Most municipalities are on the payments basis, which the VAT Act allows for municipalities: output VAT becomes payable to SARS when the cash is received from the customer, not when the invoice is raised. Until the customer pays, the VAT on the outstanding debtors sits in what the fact sheet calls a VAT accrual account. The fact sheet is clear that no payable to SARS exists for VAT that has not been collected. It also says the set-off requirements are not met for the VAT accrual, so separate presentation is the more appropriate treatment, and netting the accrual against the receivable has no basis once the whole balance is one contractual receivable.
The fact sheet stops at classification and presentation; it does not spell out how to measure the VAT accrual on debt that the municipality does not expect to collect. This is where practice varies and where the auditors test one thing above all: consistency. The receivable, the loss allowance and the VAT accrual should be built on the same collection assumptions and disclosed on the same basis. If the matrix says 70 percent of an aged balance will never arrive, the VAT on that 70 percent will never become payable either, and the statements should not present it as if it will. The approach we apply is to keep the VAT accrual in step with the amount expected to be collected, show the movement, and explain the basis in the accounting policy and the debtors note. Whichever policy a municipality adopts, it must be written down, applied every year and disclosed.
For the minority of entities on the invoice basis, the output VAT has already been paid to SARS when the invoice was raised. The receivable is still impaired at the VAT-inclusive amount, and when the debt is finally written off as irrecoverable the VAT Act allows the VAT already paid to be recovered as a deduction. That recovery is a separate item and should not be used to reduce the impairment before the write-off actually happens.
Three related mistakes worth checking for
The first is running the provision matrix on VAT-exclusive balances because the billing system reports them that way. The matrix rates are the same; the balances they are applied to must be the amounts the customers actually owe.
The second is netting the VAT accrual against debtors on the statement of financial position. Fact Sheet 11 treats set-off of the VAT accrual as inappropriate, and an auditor will ask for the gross amounts in any case.
The third is letting the VAT accrual grow untouched for years while the underlying debt is impaired and eventually written off. Write-offs under the credit control policy should reverse the related VAT accrual at the same time, and the two reconciliations should be done together at year end.
Year-end checks on VAT in consumer debtors
- Confirm the age analysis used for the impairment is VAT inclusive and agrees to the debtors control account.
- Apply the provision matrix to the VAT-inclusive balances, by segment and age bucket.
- Reconcile the VAT accrual to the VAT on outstanding debtors, and present it separately from both the receivable and the VAT payable to SARS.
- Write down the policy for measuring the VAT accrual on impaired debt, and apply it consistently.
- Reverse the related VAT accrual when debt is written off, in the same period.
- Disclose the treatment in the accounting policy and the debtors note, with reference to GRAP 104 and Fact Sheet 11.
Where we help. Ambition Partners Advisory reviews the VAT treatment as part of every GRAP 104 and GRAP 108 impairment model we build or review, including the reconciliation of the VAT accrual and the disclosure note. Read about the service or message us on WhatsApp.
Discuss your municipality’s requirements
Ambition Partners Advisory is a Chartered Accountant (SA) led practice working with municipalities, municipal entities, government departments and public entities across South Africa. Tell us where you are in the reporting cycle and we will send you a scope, timeline and fee.