Sales Tax, also known as Value Added Tax, is applied on most goods and services. It is a form of indirect tax bourne by the ultimate customer. Company making sales to a customer collects the sales tax from the customer on behalf of the tax authorities. The company is therefore acting as an agent of government as a collector of sales tax.
A company itself also pays tax in respect of the purchases of goods and services from other suppliers. However, the company would be able to recover the tax paid on such purchases from the tax authorities. What the company finally pays or receives is the difference between sales tax it collected from customers (output tax) and sales tax it paid on purchases (input tax). If the output tax exceeds the input tax, the company will pay the difference to tax authorities. Conversely, if input tax exceeds the output tax, then it may recover the difference from tax authorities. The settlement of sales tax is processed by the submission of periodic tax returns by the company.
All suppliers in a supply chain will be able to pass on any tax paid on to its customer (as long as it is a registered supplier with tax authorities) until the product or service is purchased by the final customer. Such customers cannot recover the input tax they pay on their purchase and are therefore the ultimate payers of sales tax. Companies are also final consumers in respect of certain goods and services that they consume.
Accounting for Sales Tax on Purchases
Since an entity will recover sales tax it pays on purchases, input tax must not be shown as an expense. Therefore, purchases are shown net of any sales tax paid. The accounting entry to record purchases involving sales tax will therefore be as follows:
|
Debit |
Sales Tax (Receivable) (Tax Amount) |
|
Debit |
Purchases (Net Amount) |
|
Credit |
Payable (Gross Amount) |
The payable includes the amount of sales tax since it will be paid to the supplier. Purchases are recorded net of sales tax because any input tax paid on the purchases will be recovered from tax authorities and hence, does not form part of the expense. Sales Tax account is debited since this is the amount of sales tax recoverable from the tax authorities.
Where the initial purchase was made on credit, subsequent payment of dues to the supplier will result in the following double entry:
|
Debit |
Payable (Gross Amount) |
|
Credit |
Cash (Gross Amount) |
Example: Sales Tax on Purchases
Bike LTD purchases a mountain bike from BMX LTD for $115 on credit. Sales tax is 15%.
As the purchase of $115 includes an element of sales tax, we need to first separate tax from the gross amount. Input tax on the transaction may be calculated as follows:
Sales Tax: 115 x 15/115 = $15
Deducting sales tax from the gross purchase, we may now arrive at the tax exclusive purchase value:
Tax Exclusive Purchases: 115 – 15 = $100
This is the amount to be recognized as purchases in the income statement. The accounting entry will therefore be as follows:
|
Debit |
Sales Tax (Receivable) |
$15 |
|
Debit |
Purchases |
$100 |
|
Credit |
BMX LTD (Payable) |
$115 |
Upon payment of the amount payable to BMX LTD, following double entry will be made:
|
Debit |
BMX LTD (Payable) |
$115 |
|
Debit |
Cash |
$115 |
The sales tax receivable of $15 will stand till it is recovered from tax authorities.