VAT - a simple guide

TO FULL COST APPORTIONMENT

1. The Full Cost Apportionment Method

This method utilises the relationship between the cost of making the supply of goods and the cost of making the supply of dispensing services in order to determine the respective selling prices of the goods and dispensing service. It assumes that the relationship between the costs of making the two supplies is the same as the relationship between the two supplies when they are sold to the patient. Essentially this means that the profit margin on the sale of the spectacles is split proportionately between the goods and the dispensing service. If a business is able to provide support for an alternative attribution of the profit between the goods and services, which for example weights the attribution to the professional service, it will be necessary to produce satisfactory evidence to Customs.

Consequently, in order to operate this method it is necessary to determine the cost of the goods being supplied to the patient and also the cost of providing the service of dispensing the spectacles.

2. Cost of Goods

In establishing the cost of goods, it is necessary to determine the average cost of frames and lenses plus the cost of any glazing which is performed in-house.

a) Frames and Lenses

It is suggested that the initial calculation is based upon the purchases which have been made in a financial year, rather than in a VAT year, as the information should be more readily available.

You should extract from your accounting records for the year in question the following information:

• the number of frames purchased in the year;
• the cost of the frames purchased in the year excl.VAT;
• the number of lenses purchased in the year;
• the cost of the lenses purchased in the year excl. VAT;

Note: Opticians may include in certain instances, and at certain times as part of a promotion, spectacle cases or other items within the total cost of the sale of a pair of spectacles. These items should be excluded for the purpose of this calculation.

Once the figures have been extracted from the financial accounts an average value of the cost of frames and lenses can be calculated as follows:

If it is not possible to identify the number of frames or lenses purchased in the year from the purchase invoice, the total cost of frames and lenses and the number of spectacles dispensed in the year may be used. Whilst this method will not take account of changes in stock it will produce a result which can be used in the Full Cost Apportionment calculation.

b) In-house Glazing Costs

To establish the cost of in-house glazing, it is necessary to determine the cost of labour and consumables used in the glazing process.

The labour cost will be the wages paid to the technician including PAYE and employers National Insurance. Where glazing is undertaken by either an OO or DO, an apportionment of their cost should be established by reference to the time spent on glazing.

Note: Any indirect costs which are incurred by the business, such as general overheads and depreciation on fixed equipment, should not be included for the purposes of this calculation.

The calculation to determine the average labour cost of glazing is as follows:

C) VAT Inclusive Costs

With effect from 1st April 1999, it is necessary to add VAT at 17.5% to the cost of goods in order to correctly apply the formula to the VAT inclusive selling price of the spectacles. VAT should be added to all costs irrespective of whether they bore VAT when purchased.

3. Cost of Service

In any practice there may be both an Ophthalmic Optician (OO) and a Dispensing Optician (DO). An OO is permitted to carry out sight tests and also dispense spectacles and contact lenses, whereas a DO is only permitted to dispense spectacles and contact lenses.

In order to determine the cost of service for the purpose of the Full Cost Apportionment calculation, it is necessary to calculate the costs of the OO, DO and also any non-registered person who works under the direct supervision of an optician enrolled with the General Optical Council who can be considered Directly Supervised Persons (DSP’s). Once these costs have been established, it will be necessary to determine the involvement in the dispensing of spectacles.

OO's and DO's who own the business

In smaller practices, it is common for the business to be owned by the OO's or DO's who are also the professional staff within the business. In such circumstances, it is necessary to be able to determine the cost to the business of receiving the professional services of the owner. The methodology will be dependent upon the status of the business.

Sole Practitioner and Partnerships

In these types of business, the professional cost can be achieved by using the drawings figures from the financial accounts. In determining the drawings, it is necessary to take account of all the benefits which are received from the business plus any payments which are made by the business on behalf of the individual such as income tax liability. However, this can be affected by various factors, including market conditions and an average should be established by using drawings from the business for the last 3 years.

Limited Company

To determine the direct cost of an OO who is a director of a limited company and is actively involved in the provision of professional services, you will need to consider the salary paid as per the financial accounts, plus the payment of any dividend to him, in order to obtain a fair and true position. It is also necessary to include any benefits in kind which are paid to the director such as the provision of a car. It may be necessary to consider the salary and dividends paid over a three year period to obtain an average value.

Employed OO's, DO's and DSP's

For professional staff who do not own the business, it is necessary to calculate the direct costs of employing the individuals.

When calculating the direct cost of OO's DO's and DSP's the following principal costs will need to be included: (This is not necessarily an exhaustive list).

• Salary
• Employers National Insurance Contributions
• Pension contributions by employer
• Cost of provision of vehicle to OO's and DO's involved in dispensing of spectacles
• Optical training of opticians and supervised persons
• Professional body subscriptions incurred by the practice
• Professional indemnity costs incurred by the practice
• Recruitment costs

Having calculated the average cost of the professional staff, it is necessary to establish their cost in the dispensing of spectacles. This may be achieved as follows:

OO's

The OO is involved in the dispensing of spectacles and contact lenses and the provision of sight tests. Consequently, it is necessary to determine the proportion of their costs which are attributable to the dispensing of spectacles.

If the OO is not involved in the dispensing of spectacles and merely carries out sight tests, there is no justification for the inclusion of any of their costs.

However, in the majority of businesses the OO is actively involved in the dispensing of spectacles and so it is appropriate to include a proportion of their costs when determining the cost to the business of dispensing spectacles.

If the OO maintains a record of the amount of time which they spend on the various activities which they perform, it may be possible to use this record as the basis for determining the involvement of the OO in the dispensing process.

However, it must be recognised that time may not be the only factor which needs to be taken into consideration when establishing the value of the involvement of the OO in the dispensing process. If an OO does not maintain any records, it would be difficult to determine their involvement in the spectacles dispensing process on a time basis due to the complexity and diversity of the tasks which they undertake.

If no time records are maintained, and the maintenance of such records cannot be imposed upon an optician, one method of determining the costs attributable to the dispensing of spectacles would be to use the following calculation:

The result of this calculation can be substantiated by the OO demonstrating their degree of involvement in the dispensing process.

Whether a business wishes to adopt this or an alternative method, it will be necessary to agree this with Customs.

When determining whether any method is capable of producing an acceptable result, it must be remembered that the method must be based on information which can be readily verified by Customs. Consequently, it is not possible to use arbitrary percentages on the basis that it is not possible to determine whether they are correct.

DO's

As the DO is involved in the dispensing of spectacles and contact lenses, their costs attributable to the dispensing of spectacles can be determined by the following calculation:

Directly Supervised Persons (DSP)

A proportion of the direct labour costs of DSP's who are involved in the dispensing of spectacles can be included in the Full Cost Apportionment calculation. In determining the level of the costs to be included it may be appropriate to use an income based calculation similar to that used for OO's and DO's but with the denominator being the total of the income which is generated by the DSP's (this is likely to be the total of the spectacles plus accessory income.)

However, the actual percentage of these costs will need to be agreed by the VAT registered optician and the LVO/VSO and may vary from practice to practice.

The cost of service should also include any VAT which is incurred in the costs of making the exempt supply of dispensing spectacles.

4. Calculation of income from spectacle sales attributable to taxable supplies

As the costs of supplying both the goods and services have now been calculated, it is possible to determine the amount of VAT due the dispensing of spectacles. This amount of VAT due is achieved using the following formula:

5. Recalculation

Customs & Excise would not expect a business to have to recalculate their percentages attributable to taxable and exempt supplies, unless there has been a material change to the business or three years have elapsed since the last calculation.

6. For the future

If you decide to implement the Cost Apportionment method, it will be as well to consider whether you need to alter current book-keeping practices so as they will allow you to extract any required information easily.

Written by Shaun King of Ernst & Young - VAT adviser to FODO