Sales Tax
1 Introduction
In this chapter we will explain the principles of the operation of a sales tax (e.g. VAT in the UK).
We will also explain how to calculate the sales tax on transactions, and the effect on the accounting entries.
2 The principles of sales tax
If a business is registered with the state for sales tax, then they are required to add the tax to the price of all their sales. They are acting as tax collectors for the state, and the tax that they have charged on their sales is payable to the state periodically (in some countries it is accounted for monthly and in some countries three-monthly). The tax charged on their sales is known as output tax.
However, the business will have suffered (i.e. will have been charged) sales tax on their purchases. The tax they have suffered is known as input tax.
At the end of each period, the excess of the output tax collected by the company over the input tax suffered by the company is payable to the state.
If in any period the input tax exceeds the output tax then the difference will be repaid by the state.
Illustration:
3 The calculation of sales tax
The rate of sales tax is determined by the state and differs from country to country. Also, many countries have different rates of sales tax depending on the nature of the item being sold.
Some businesses quote their selling price without sales tax, and then add the relevant percentage. Other businesses (particularly shops selling to the general public) quote a selling price including sales tax.
It is important in the examination to be able to identify the net sales price, the gross sales price, and the amount of sales tax.
Alpha sells goods at a net (or tax exclusive) price of $150.
The rate of sales tax is 16%.
What is the gross (or tax inclusive) selling price?
Show answerHide answer
Beta sells goods at a gross (or tax inclusive) price of $120.
The rate of sales tax is 16%.
What is the net (or tax exclusive) selling price, and what is the amount of the sales tax?
Show answerHide answer
Gamma sells goods at a gross (or tax inclusive) price of $220.
The rate of sales tax is 17.5%.
What is the net (or tax exclusive) selling price, and what is the amount of the sales tax?
Show answerHide answer
4 The accounting entries
Input tax
When a company makes purchases, the amount charged will include sales tax, but the tax suffered will be recovered from the state.
The entry is therefore:
Dr Purchases (with the net cost)
Dr Sales tax (with the amount of the tax)
Cr Payables / Cash (with the gross cost)
Output tax
When a company makes sales, the amount charged includes sales tax, but the tax collected will be paid to the state.
The entry is therefore:
Dr Receivables / Cash (with the gross amount)
Cr Sales (with the net amount)
Cr Sales tax (with the amount of the tax)
The balance on the Sales Tax account will represent the amount of sales tax owing to or from the state.
If, at the end of the period, there is a credit balance, then the balance will be paid to the state:
Dr Sales tax
Cr Cash
If alternatively there is a debit balance, then the state will repay the business:
Dr Cash
Cr Sales tax
(note that more commonly a debit balance is not repaid, but is left on the account to reduce the payment to the state in the following period)
Delta’s purchases and sales for December are as follows:
Net | Sales tax | Gross | |
Purchases on credit | 432,000 | 75,600 | 507,600 |
Sales on credit | 624,000 | 109,200 | 733,200 |
Show answerHide answer
Sales Tax
5 questionsAnswer the questions one at a time. Your progress is saved so you can leave and come back.
Open chapter practice