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What is Sales Tax?

Money raised by governments to pay for amenities (roads, fire halls, garbage pickup, military protection, etc)

Also referred to as Consumption Tax

In Canada, sales taxes are charged by the federal government, and most provincial governments

July 1, 2010 – 13% HST (Ontario Harmonized Sales Tax) (Canada GST/HST Info Sheet)

In US, most states & some cities (eg Chicago) charge sales tax

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Different names – same principle

When taxes are collected by a business on behalf of the government they are called different names relating to different taxes• GST (Goods & Service Tax

• PST (Provincial Sales Tax )

• VAT (Value Added Tax):

• HST (Harmonized Sales Tax):

• Sales and Use Tax

They all work on the same principle - we will use GST of 5% as the example to demonstrate the concept

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Some governments include the tax within the sales price while others bill them separately

The sales price is not the total price

E.g. Buy clothing for $100. The sales bill or advertisement will read $100 for the clothes plus 5% GST for total of $105

If GST is included then the advertisement will read $105 including both the cost of the clothes and the GST combined

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In either event, the store will keep the $100 representing the sale of the clothes but the $5 GST collected does not belong to the store.

It needs to be paid to the government and is recorded as a liability on the stores records.

The sales price is not the total price

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Sell clothing for cash $100 + 5% GST

1. Record the sale$100 (Dr)$100 (Cr)

There are 2 transactions

$5 (Dr)

2. Record the GST. This is a liability because it needs to be paid to the government

$5 (Cr)

Summary: The store collected $105 in cash - $100 belongs to the store and $5 belongs to the government

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Pay the GST to the government

When it’s time to pay the government, cash will decrease (Cr) and the tax liability will decrease (Dr)

- $5 (Cr)

- $5 (Dr)

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Taxes are sometimes referred to as Value Added Taxes are sometimes referred to as Value Added Tax because each business in the customer Tax because each business in the customer service chain keeps adding to the value of the taxservice chain keeps adding to the value of the tax

Manufacturer buys raw

material from a supplier –

supplier charges GST

Manufacturer sells finished

goods to wholesaler – charges GST to wholesaler

Wholesaler sells goods to

a retailer – charges GST

to retailer

Retailer sells to customer – charges GST to customer

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Simplified Example

Seller Buyer Price GST Rec’d by Seller

Seller’s GST Payable to CRA

Fabric supplier

Dress manufacturer

$50 $2.50 $2.50 less GST paid on threads, etc

Dress manufacturer

Wholesaler $100 $5.00 (5.00 – 2.50)$2.50

Wholesaler Dress store (retailer)

$200 $10.00 (10.00 – 5.00)$5.00

Dress store (retailer)

Consumer $400 $20.00 (20.00 – 10.00)$10.00

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Individuals (Consumer) may be entitled to a GST/HST credit of up to $250.00 (for 2009 tax year)

The GST system allows those further down the line (manufacturer, wholesaler, retailer) to recover the GST paid

The administration of GST requires both a GST GST PaidPaid, and a GST Collected GST Collected account

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Bookkeeping example of GST tax transactionsBookkeeping example of GST tax transactions

Assume the current GST rate is 5%

Gifts & More Gifts & More buys a product for resale for cash from a wholesaler for $100$100

What is the journal entry?

General JournalAccount Title and Explanation Debit Credit

Inventory $100

GST Paid $ 5

Cash $105

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Gifts & More Gifts & More sells their inventory costing $100 to a customer for $200 $200 cash.

What is the entry required?

General JournalAccount Title and Explanation Debit Credit

Cash $210

$210

Revenue $200

$200

GST Collected $ 10

$10

1. Record the sale

There are 2 transactions

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What is the second part of the entry required?

General JournalAccount Title and Explanation Debit Credit

Cost of Goods Sold $100

$100

Inventory $100

$100

2. Record the Cost of Goods Sold

General JournalAccount Title and Explanation Debit CreditCash $210Revenue 200GST Collected 10

Cost of Goods Sold 100Inventory 100

Summary: The store collected $210 in cash - $200 belongs to the store and $10 belongs to the government

Notice how you recognized the COGS in the amount of $100 which is matched to the sale value of $200

SummarySummary

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+$210 (Dr) +$200 (Cr)

+$10 (Cr)

+$100 (Dr)

-$100 (Cr)

GST is charged on sales at all levels

Later on, (usually the following month for large companies and quarterly for “small businesses”) Gifts & More Gifts & More must send the tax collected to the government

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It is now time to pay the government for GST - Gifts & More Gifts & More pays the government the difference between GST collected $10 and GST paid $5

If it happens that more GST was paid than collected, the federal government would owe Gifts & More Gifts & More the difference

What is the entry?

General JournalAccount Title and Explanation Debit Credit

GST Collected $10

GST Paid $5

Cash $5

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Review :

Why is sales tax a liability & not an expense?

Sales tax is always recorded as a liability because it is collected on behalf of the government and is therefore owed to the government

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Lets Try another Exercise together!

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Tools Suppliers Inc. (TSI) buys products totaling $150, on account, for sale (profit) at a later time.

$150

$150

What is the journal entry?

Account Title and Explanation Debit Credit

Inventory $150

Accounts Payable $150

Purchased product for resale

Tools Suppliers Inc.

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Record the sales tax of $7.50 (5% of $150) owing by TSI to their supplier (on Account):

$7.50

$7.50

What is the journal entry?Account Title and

Explanation Debit Credit

Sales Tax $7.50

Accounts Payable $7.50

Sales tax owing on purchase

Tools Suppliers Inc.

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TSI sells the products to Sheet Manufacturers Ltd. (SML) for $200 (their cost was $150), plus tax of $10. This amount is owing by SML (accounts receivable).

The journal entry is……..

$10

$200

$210

Account Title and Explanation Debit Credit

Notice how the transaction combines the sales of the product and sales tax owing together as one compound entry unlike the previous slide where it was done separately.

Accounts Receivable $210

Revenue $200

Sales Tax $ 10

Record sale of product

Tools Suppliers Inc.

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Here is a summary of the activities on the records of TSI:

Sales Taxes

Dr Cr

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$7.50

• TSI paid $7.50 in sales tax when they purchased the product

• They billed $10 in sales tax when they sold the product

$10.00

• Therefore they collected $2.50 more in sales tax than they paid which is now owing to the government

$ 2.50

The journal entry for the payment of sales tax in the amount of $2.50 to the government would be:

Account Title and Explanation Debit Credit

Paid sales tax to government$2.50

Sales Tax $2.50

$2.50

Cash $2.50

? ?Tools Suppliers Inc.

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And now the last company in the chain of supply- Sheet Manufacturers Ltd. (SML)SML buys the product from TSI

Account Title and Explanation Debit Credit

$200

$10

$210

Record the journal entry, which should include sales tax.

Inventory $ 200

Sales Tax $10

Accounts Payable $ 210

Purchased product for resale

Sheet Manufacturers Ltd.

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And the Final step is the sale of the product by SML to the final customer

SML sells the product for $300, plus 5% sales tax.

SML pays the government the sales tax collected (they paid $10, collected $15, and must pay the difference to the government.

Account Title and Explanation Debit Credit

Account Title and Explanation Debit Credit

What is the entry?

What is the entry?

Cash $315

Revenue $300

Sales Tax $15

Record sale of product, including tax

Cash $5

Sales Tax $5

Paid sales tax to government25

And now ….

Back to Paralegal Bookkeeping …

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