Sales Tax, also known as Value Added Tax, is applied on most goods and services. It is a form of indirect tax bourne by the ultimate customer. Company making sales to a customer collects the sales tax from the customer on behalf of the tax authorities. The company is therefore acting as an agent of government as a collector of sales tax.
A company itself also pays tax in respect of the purchases of goods and services from other suppliers. However, the company would be able to recover the tax paid on such purchases from the tax authorities. What the company finally pays or receives is the difference between sales tax it collected from customers (output tax) and sales tax it paid on purchases (input tax). If the output tax exceeds the input tax, the company will pay the difference to tax authorities. Conversely, if input tax exceeds the output tax, then it may recover the difference from tax authorities. The settlement of sales tax is processed by the submission of periodic tax returns by the company.
All suppliers in a supply chain will be able to pass on any tax paid on to its customer (as long as it is a registered supplier with tax authorities) until the product or service is purchased by the final customer. Such customers cannot recover the sales tax they pay on their purchase and are therefore the ultimate payers of sales tax. Companies are also final consumers in respect of certain goods and services they consume and must therefore bear sales tax on such purchases.
Since an entity is only collecting sales tax on behalf of tax authorities, output tax must not be shown as part of income. Therefore, sales revenue is shown net of any sales tax received from customers. The accounting entry to record the sale involving sales tax will therefore be as follows: