Many tax jurisdictions have a form of sales tax, which is a tax on the final customer of the good or service. In affect businesses collecting this tax are agents for the tax authority and have to remit this back within a specified time. Therefore the accounting entries to properly track sales tax are critical to ensuring these agent responsibilities are properly discharged.
This article builds on our earlier article dealing with withholding tax.
Indirect Taxes
The accounting for sales can vary between tax jurisdictions depending on whether the reporting entity also pays sales tax on its purchases, often referred to as an input tax. And then collects sales tax on its sales to customers, often referred to as an output tax.
You normally only find this in jurisdictions dealing with “value added tax”, for example in the United Kingdom with its VAT regime. We will produce a separate article for the journal entries involved with this setup.
For our article today we are assuming that our reporting entity only collects sales tax from its customers, but does not pay sales tax on any of its own purchases.
Accounts
We will only be dealing with three accounts for our sales tax example. Two of them, bank and debtors, you of course will be familiar with and the debits and credits involved.
Our third account will be the sales tax liability account that will be used to record the recollection of sales tax as the business makes sales through a month. The tax is recognised as a liability because it is not for the reporting to use as it wishes, but rather it must be passed onto a tax authority. So it meets our definition of a liability:
… being the creation of an obligation to a third party to give up economic benefits at some point in the future as a result of a past event.
Sales Tax Accounting Journal Entries
ABC Ltd is our trusty example business, which is registered for sales tax in its State. ABC has two sales taxes to collect for in our example. There is a 10% State sales tax and a 5% local sales tax. To ensure we keep proper track of both, two different sales tax liability accounts are used.
On October 3rd ABC Ltd makes a $100.00 (sales tax exclusive) sale to one of its customers. The customer has an account with ABC and so is able to put this on credit; balance due 20 days after invoice date.
Now we have all the information we need, we can make the following journal entry:
| Date | Account Name | Debit | Credit |
|---|---|---|---|
| 3 October | Debtors | $115.00 | |
| Sales | $100.00 | ||
| Sales Tax – State | $10.00 | ||
| Sales Tax – Local | $5.00 |
At the end of the month ABC has to remit the sales taxes collected to the respective tax authority; which it is required to do for both by the 20th day of the month following. It will clear the balance in the sales tax liabilities by a payment, reducing its bank balance (the journal below assumes for this example ABC did not have any other sales tax related sales for the month).
| Date | Account Name | Debit | Credit |
|---|---|---|---|
| 20 November | Bank | $15.00 | |
| Sales Tax – State | $10.00 | ||
| Sales Tax – Local | $5.00 |
ABC has trade debtor terms and conditions that require payment within 20 days of the invoice being raised. In this case the customer pays early, only a week after the invoice being raised.
| Date | Account Name | Debit | Credit |
|---|---|---|---|
| 10 October | Bank | $115.00 | |
| Debtors | $115.00 |
Conclusion
Sales taxes, although can be complex in regards to specific tax regulation, create straight forward accounting entries. We hope you have found this article useful to further your understanding of the journal transactions involved. Please comment below, rate the article or drop us a note through the Contact Us if you have any questions.