Sales tax accounting involves asset, revenue, and liabilities accounts such as Sales Revenue, Cash, and Sales Tax Payable.
Accounting for sales tax is not too complex if you understand the basics of accounting from our previous lessons.
This article will refresh those basic accounting concepts and give you examples of small business sales tax accounting journal entries.
Since we are basically serving as revenue collection agents for state governments…
we should not show collected sales tax as income in our accounting records…
nor should they be represented as an expense when you remit those collected sales taxes.
Below are examples of journal entries that reflect that concept.
But first of all, let’s discuss exactly what accounting for sales tax includes.
Most states levy sales taxes on goods and services. Those states differ on what is taxed and for how much. Some states tax goods but not services. Some states tax food sold in restaurants but not food sold in grocery stores.
As small business owners it is very important for us to research our state tax laws and be aware of the specific sales taxes. You can usually find this information on your state’s tax commission website. You should not only research their website, but also call and talk to a representative on how to set up and transmit collected sales taxes.
Sales tax payable is a liability account to track the sales taxes that were collected from the sale of taxable products and services.
Sales tax payable is a current liability account; however, it accounts for sales taxes owed to the government. The account represents our obligation to transmit those collected sales tax on to the appropriate tax authority.
The short answer is sales taxes are not an expense, but instead a liability.
In states where there is a sales tax, when a business sells a taxable product or service to the end-user of that product or service, the business charges and collects a sales tax from the customer.
The business now has to pay the collected sales taxes to the relevant taxing authorities. When the business receives the sales taxes, a credit is made to the sales taxes payable account and debits the cash account. After the funds from sales taxes are submitted to the taxing authorities, the sales tax liability is removed.
The funds collected from sales taxes are not a part of revenues and will not show up on the income statement. Those funds will instead show up on the balance sheet as a current liability.
As you set up your sales tax accounting, be aware that there is difference between accounts that we discussed in a previous accounting lesson and sales tax payable.
Accounts payable is a current liability account in your chart of accounts that accounts for invoices that your business owes and pays.
How to Record Sales Tax Journal Entries
Sales tax accounting involves assets, revenue, and liability accounts.
Gross sales are recorded using asset accounts such as Cash or Accounts Receivable. Net sales are recorded using revenue accounts such as Sales Revenue. The sales taxes collected is recorded using a current liability account such as Sales Tax Payable.
Note: If your small business collects sales taxes from multiple states, it is a good idea to set up a separate sales tax payable accounts for each state. It makes it easier to remit sales taxes to the appropriate government agencies.
The following is an example of some of the accounts you may set up to manage and record sales tax:
· Cash
· Accounts Receivable
· Sales Revenue
· Sales Tax Payable
In this section of sales tax accounting, we will use a fictitious company to provide examples of journal entries to record sales, collected sales taxes, and remitted sales taxes.
These journal entries can be used in a manual accounting system and also in a computerized accounting system such as QuickBooks.
Examples:
ABC Company sold a customer $100.00 worth of thingamajigs on which there is a ten percent sales tax.
Journal Entry #1:
|
Date |
Account Names |
Debit |
Credit |
|
3/1 |
Cash or Accounts Receivable (gross amount) |
$110.00 |
|
|
|
Sales Revenue (net sale amount) |
|
$100.00 |
|
|
Sales Tax Payable (tax amount) |
|
$10.00 |
In the above example, the customer purchased $100.00 of ABC Company’s products and ABC Co. collected $10.00 in sales tax (based on a sales tax rate of 10%). They received a total of $110.00 from their customer which they recorded in their Cash account (if the customer paid in cash) or in their Accounts Receivable account (if the customer paid on credit).
Remember your basic accounting concepts?
· Debit assets to increase them. (You would increase your Cash or Accounts Receivables at the time of the sale.)
· Credit revenue and liability accounts to increase them. (You would increase your Sales Revenue account with the sales amount minus the sales taxes. You would also be increasing your Sales Tax Payable account with the collected sales tax amount.)
At the end of the month, ABC Co. remitted their collected sales tax to the appropriate government agency.
Journal Entry #2:
|
Date |
Account Names |
Debit |
Credit |
|
3/31 |
Sales Tax Payable |
$500.00 |
|
|
|
Cash |
|
$500.00 |
In the above example, ABC Co. filled out a sales tax remittance form that itemized their month’s sales and sales taxes and sent the government the amount of the sales tax recorded in their sales tax payable account which included the $10.00 collected on the March 1st sale in journal entry #1.
Some small business owners are unable to or choose to NOT separate the sales revenue and sales tax at the time of the sale. In this case, you would need to make an extra journal entry to move sales taxes back out of the Sales Revenue account and into its own account (Sales Taxes Payable). An example of the journal entries would be:
When you sell products to customer:
Journal Entry #3:
|
Date |
Account Names |
Debit |
Credit |
|
3/1 |
Cash or Accounts Receivable |
$110.00 |
|
|
|
Sales Revenue |
|
$110.00 |
Then when you determine the amount of the sales tax you would post the following journal entry:
Journal Entry #4:
|
Date |
Account Names |
Debit |
Credit |
|
3/31 |
Sales Revenue |
$10.00 |
|
|
|
Sales Tax Payable |
|
$10.00 |
As in method one, when it is time to send in the collected sales tax to the appropriate government agency, you would record a journal entry to represent emptying out the sales tax payable account (debit amount to decrease liability account) and decreasing our cash (credit amount to decrease asset account). See journal entry #2.