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 sales 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 they consume and must therefore bear sales tax on such purchases.
Accounting for Sales Tax
Since an entity is only collecting sales tax on behalf of tax authorities, output tax must not be shown as part of income. Therefore, sales revenue is shown net of any sales tax received from customers. The accounting entry to record the sale involving sales tax will therefore be as follows:
|
Debit |
Cash / Receivable (Gross Amount) |
|
|
Credit |
Sales (Net Amount) |
|
|
Credit |
Sales Tax Payable i.e. Output Tax (Tax Amount) |
|
The receivable includes the amount of sales tax since it will be recovered from the customer.
Sales is recorded net of sales tax because any sales tax received on the sales will be returned to tax authorities and hence, does not form part of income.
Sales tax account is credited since this is the amount of tax payable that will be paid to tax authorities.
Where the initial sale was made on credit, subsequent receipt of dues from the customer will result in the following double entry:
|
Debit |
Cash (Gross Amount) |
|
|
Credit |
Receivable (Gross Amount) |
|
Sales Tax Example
Bike LTD sells a mountain bike to XYZ for $115 on credit. Sales tax is 15%.
As the sale of $115 includes an element of sales tax, we need to first separate tax from the gross amount. Sales tax on the transaction may be calculated as follows:
Sales Tax: 115 x 15/115 = $15
Deducting sales tax from the gross sale revenue, we may now arrive at the tax exclusive sale value:
Tax Exclusive Sales: 115 – 15 = $100
This is the amount to be recognized as sales in the income statement. The accounting entry will therefore be as follows:
|
Debit |
XYZ (Receivable) |
$115 |
|
Credit |
Sales |
$100 |
|
Credit |
Sales Tax Payable i.e. Output Tax |
$15 |
Upon receipt of the amount receivable from XYZ, following double entry will be made:
|
Debit |
Cash |
$115 |
|
Credit |
XYZ (Receivable) |
$115 |
The sales tax payable of $15 will remain outstanding until it is paid to the tax authorities.