When you sell a product or when you buy something?

Here's the answer for both situations: For a sale: Debit.......... cash or A/R Credit......... Revenue Credit......... Sales Tax payable. Then, when you pay the tax to the state: Debit........... Sales tax payable Credit.......... cash If it's a purchase, you don't have to record sales tax separately unless you want to. If you're capitalizing an asset, it's included in the capitalized amount. But if it's a straight expense, and you want to post the sales tax, this would be the entry: Debit........ expense account (say, for example, office expense) Debit........ sales tax Credit....... cash or A/P

Taxes Payable Governments levy taxes on individuals and companies primarily to fund programs. For example, amounts received from federal income taxes are used to fund military, educational, and numerous other federal government programs. In addition to federal income taxes, there are many taxes affecting companies. For example, international companies must be aware of taxes in every country in which they do business, as well as, many states in the United States. In this chapter, the liabilities resulting from three specific taxes affecting companies will be examined: sales taxes, income taxes, and payroll taxes. Sales Taxes Payable Sales taxes payable are current liabilities resulting from products and services sold to customers. Most states levy sales taxes, although they vary significantly on what is taxed and the tax rate. For example, some states tax food sold in restaurants but not in grocery stores. Other states tax products but not services. Companies selling products and services must be aware of the specific sales taxes in the states in which they operate. Companies are responsible for charging their customers the appropriate sales taxes and paying state governments. Through this process companies act as revenue collection agents for state governments. Assume the Nicholas Corporation sells merchandise on account to its customers on November 3. The merchandise has a $1,000 sales price and the state in which the company is doing business has a 5% sales tax. Show the effects on the company's resources and sources of resources of the November 3 sales.
Sources of Borrowed Resources Sources of Owner Invested Resources Sources of Management Generated

Total Resources

Assets + $1,050 accounts receivable

= =

Liabilities + $50 sales taxes payable

Resources Stockholders' Equity + + $1,000 sales

The company's resources (assets) increased because the company received $1,050 of promises (accounts receivable) from customers. The company's liabilities increased because $50 of the accounts receivable do not belong to the company, but are owed to the state government. The company's stockholders' equity increased by the $1,000 generated by management (sales). It is important to note that while the company's resources increased by $1,050, only $1,000 belongs to the company. The other $50 is owed to the state and, thus, appears as the current liability, sales taxes payable. This $50 is a result of the company acting as a revenue collection agency for the government. Remembering that assets increase with debits and debits equal credits, prepare the journal entry to record the November 3 sales.

Date Description Nov. 3 Accounts Receivable Sales Taxes Payable Sales Sales on account

Post. Ref.

Debits 1,050

Credits 50 1,000

States have payment schedules for companies to follow when paying sales taxes. Companies must pay the sales taxes by the appropriate date or be subject to penalties. For example, assume the state in which the Nicholas Corporation operates requires sales taxes to be paid by the 10th day of the month following the sales. Assume also the Nicholas Corporation charged its customers a total of $16,000 for sales taxes in November. Show the effects on the company's resources and sources of resources of paying November's sales taxes on December 8.
Sources of Sources of Management Owner Invested Generated Resources + Resources Stockholders' Equity

Total Resources Assets - $16,000 cash

= = =

Sources of Borrowed Resources Liabilities - $16,000 sales taxes payable

+ +

The payment of sales taxes reduced the company's resources (assets) and sources of resources (liabilities). As a result of paying the state, the company has $16,000 less cash but also owes the state $16,000 less. Stockholders' equity in not affected by the sales taxes payment because the resources were not used up by management, but were, in effect, paid to a creditor. The sales taxes are not an expense to the company. They are a cost to the customer, not to the company. Remembering that assets increase with debits and debits equal credits, prepare the journal entry to record the December 8 payment.

Date Dec. 8

Description Sales Taxes Payable Cash Sales taxes payment

Post. Ref.

Debits 16,000

Credits 16,000

** You now have the background to do text exercise 10.6 and 10.7. Income Taxes Payable Income taxes payable are liabilities resulting from companies having more revenues than expenses. In other words, as the name implies, income taxes are based on income. In addition to federal income taxes, many states also levy income taxes, although the rates vary from state to state. The actual income tax rates, both federal and state, are determined by tax authorities and are provided to companies for their use. Because the rates may change and their application can be quite complicated, companies use tax experts to calculate the amount of the taxes. The situation is further complicated by the fact that the accounting methods used for tax purposes may differ from the methods used in the preparation of financial statements. Remember FIFO and LIFO inventory methods from Chapter 8 and straight-line and accelerated depreciation from Chapter 9? In general, for tax purposes, income taxes to governments are determined according to governmental tax rules, while for financial statement purposes, income taxes are based on taxable income. As a result, it is very common that the amount of income taxes payable to governments in the near future differs from the income taxes expense reported on a company's income statement. Once again, remember how income tax payments could be postponed by using accelerated depreciation for tax purposes? If the amount of income taxes payable must be paid within 12 months, it is classified as a current liability called income taxes payable. If the amount of income taxes does not have to be paid within 12 months, it is classified as a longterm liability called deferred income taxes payable.

Assume the Nicholas Corporation uses accelerated depreciation for tax purposes but straight-line depreciation in its accounting records. As a result, the company calculates income taxes expense of $21,000 in its November accounting records. Using its knowledge of tax rules, the company calculates it will have to pay only $20,000 in income taxes in the next 12 months, while the other $1,000 will have to be paid sometime later. Show the effects on the company's resources and sources of resources of the November income taxes.
Sources of Sources of Management Owner Invested Generated Resources + Resources Stockholders' Equity + - $21,000 income taxes expense

Total Resources Assets

= =

Sources of Borrowed Resources Liabilities + $20,000 income taxes payable + $1,000 deferred income taxes payable

+ +

The company's resources (assets) do not change in November because the company does not pay the taxes until the date specified by the government. The company's liabilities increase because $21,000 is owed to the government. The $20,000 due to be paid within the next 12 months is a current liability while the $1,000 long-term liability is for payment due after 12 months. The company's stockholders' equity decreased by the full $21,000, the company's cost of governmental service used up by management in November. Remembering that assets increase with debits and debits equal credits, prepare the journal entry to record the November income taxes.

Date Description Nov. 30 Income Taxes Expense Income Taxes Payable Deferred Income Taxes Payable November income taxes

Post. Ref.

Debits 21,000

Credits 20,000 1,000

The federal and state governments have payment schedules for companies to follow when paying income taxes. Companies must pay the income taxes by the appropriate date or be subject to penalties. For example, assume the Nicholas Corporation must pay its November taxes by December 15.

Show the effects on the company's resources and sources of resources of paying November's income taxes on December 13.
Sources of Sources of Management Owner Invested Generated Resources + Resources Stockholders' Equity

Total Resources Assets - $20,000 cash

= = =

Sources of Borrowed Resources Liabilities - $20,000 income taxes payable

+ +

The payment of income taxes reduced the company's resources (assets) and sources of resources (liabilities). As a result of paying income taxes, the company has $20,000 less cash but also owes the government $20,000 less. Stockholders' equity was not affected by the income taxes payment because additional resources were not used up by management, but were, in effect, paid to a creditor. Remembering that assets increase with debits and debits equal credits, prepare the journal entry to record the December 13 payment.

Date Description Dec. 13 Income Taxes Payable Cash Income taxes payment

Post. Ref.

Debits 20,000

Credits 20,000

** You now have the background to do text exercise 10.8, 10.9, and 10.10.

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 Cash or Accounts Receivable Sales Revenue Sales Taxes Payable Debit 107 100 7 Credit

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 Sales Taxes Payable Cash Debit 7 7 Credit

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 Cash or Accounts Receivable Sales Revenue 2) When Retailer determined amount of sales taxes: Account Titles Sales Revenue Sales Taxes Payable Debit 7 7 Credit Debit 107 107 Credit

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 Sales Taxes Payable Cash Debit 7 7 Credit