How to account for sales taxes?

February 23, 2010

1. Nature of sales taxes

Sales tax is a state or local tax on sale of products or services, based on the percentage of sales price.

When a company sells a product subject to a sales tax, the company must collect the sales tax and subsequently remit it to the appropriate government. For example, if a retailer sells a product for $100, and the state sales tax rate is 7%, then the retailer will collect $7 from the customer and then transmit that $7 to the state government.

2. Accounting for sales taxes

Sales taxes collected from customers and not yet remitted to the tax authorities are usually recorded in Sales Taxes Payable account. There are two ways to approach recording sales taxes on a company's books. Under the first method, sales taxes are reflected in their own account (Sales Taxes Payable) directly. Under the second method, sales taxes are recorded as part of the sales account (Sales Revenue) and then are moved to their own account (Sales Taxes Payable). Let's look at these two methods in more detail.

Method One of Accounting for Sales Tax

Support Retailer sells grocery products to customers, and the sales tax rate on such products is 7%. The following transactions will be recorded by Retailer:

1) When Retailer sold grocery products to customers:

Account Titles

Debit

Credit

Cash or Accounts Receivable

107

 

      Sales Revenue

 

100

      Sales Taxes Payable

 

7

In the above situation, a customer purchased $100 worth of grocery products. The sales tax that Retailer collected was $7 as 7% of $100. The total amount collected from the customer was recorded in the Cash account (if the customer paid in cash) or the Accounts Receivable (if the customer used a credit card). The sales amount without the sales taxes was entered in the Sales Revenue account. The sales taxes were credited in their own Sales Taxes Payable account. This Sales Taxes Payable account represent Retailer's obligation to transmit collected sales taxes to the tax authority during the next payment to the authority.

2) When Retailer sent the sales taxes payable to the tax authority:

Account Titles

Debit

Credit

Sales Taxes Payable

7

 

      Cash

 

7

This transaction reduces the Sales Taxes Payable account because Retailer settled its obligation to the tax authority.

Method Two of Accounting for Sales Tax

Sometimes companies do not segregate sales taxes and the sales revenues at the time of sale. In this case, companies credit the Sales Revenue account for the entire amount collected (or to be collected), which includes the sales revenue and sales taxes. Then, to transfer the sales taxes from the Sales Revenue account, companies debit the Sales Revenue account and credit the Sales Taxes Payable account. This method adds one more step in accounting for sales taxes compared to method one explained above.

Let us go back to the same example with Retailer, but now assume that Retailer initially records sales taxes into the Sales Revenue account. The following journal entries would be posted by Retailer:

1) When Retailer sold grocery products to customers:

Account Titles

Debit

Credit

Cash or Accounts Receivable

107

 

      Sales Revenue

 

107

2) When Retailer determined amount of sales taxes:

Account Titles

Debit

Credit

Sales Revenue

7

 

      Sales Taxes Payable

 

7

The sales taxes were calculated by considering that the $107 includes the sales revenue (100%) and the sales taxes (7%). So, the sales taxes were $7.

3) When Retailer sent the sales taxes payable to the tax authority:

Account Titles

Debit

Credit

Sales Taxes Payable

7

 

      Cash

 

7

Not a member?
See why people join our
online accounting course:
Lecture Contents:
Free Study Notes
Download free accounting study notes by signing up for our free newsletter (example):
First Name:
E-mail:
We never share or sell your e-mail to third parties.
Ask a Question
Suggest a Topic
Do you have an interesting question or topic?
Suggest it to be answered on Simplestudies.com: