How to record sales tax

[John Edwards]

On Mon, Oct 5, 2009 at 5:25 PM, Carl Flippin <carlf at photocarl.org> wrote:
> I understand that, when selling, one must keep sales tax in a seperate
> account to make paying sales tax easier. In the case of purchases,
> however, is it better to just include the sales tax as a part of the
> expense or should I have a seperate sales tax expense account?
>
> In case it is not clear, I am a noob to accounting in general. Is
> there a good book to learn best practices for accounting in personal
> finances?

It depends on what form of sales tax you have, and every jurisdiction
is slightly different.

In theory, the answer is this:

If it is a straight consumption tax, then the sales tax you pay is
folded into the cost of the purchase - so a $100 purchase + tax would
actually be $107 (for example). (If you're in the US, this is probably
the case. If you're in Canada, this is the case for Provincial Sales
Tax.)

If it's a value-added tax - one in which tax is collected on both
ends, but only the net difference is payable to the government - then
it's more complicated. If you're in Europe, this is almost certainly
the case. (If you're in Canada, this is the case for the federal GST
or HST. The sales tax you pay becomes an amount owed to you by the
taxing authority, as it serves to reduce the amount of you owe the
government.)

In that case, the $100 purchase + tax would be recorded as a $100
expense, and $7 to the Sales Tax Paid contra-liability account. (It's
a contra-liability, since it serves to reduce the Sales Tax
liability).

If you turn around and sell the thing for $200 + tax, you would record
a $214 debit to Cash, a $200 credit to Sales Revenue, and a $14
addition to Sales Tax Collected. Your net sales tax liability would be
$7 (the difference between what you paid and what you collected).

John

-- 
John Edwards
"You can insure against the weather, but you can't insure against
incompetence, can you?" - Phil Tufnell