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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)Harmonized Sales TaxGST/HST Info Sheet  In US, most states & some cities (eg Chicago) charge sales tax 2

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 3

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 4

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 5

Sell clothing for cash $ % 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 6

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) 7

Taxes are sometimes referred to as Value Added Tax because each business in the customer service 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 8

Simplified Example SellerBuyerPriceGST 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 WholesalerDress store (retailer) $200$10.00(10.00 – 5.00) $5.00 Dress store (retailer) Consumer$400$20.00(20.00 – 10.00) $ Individuals (Consumer) may be entitled to a GST/HST credit of up to $ (for 2009 tax year)GST/HST credit$250.00

 The GST system allows those further down the line (manufacturer, wholesaler, retailer) to recover the GST paid GST PaidGST Collected  The administration of GST requires both a GST Paid, and a GST Collected account 10

Bookkeeping example of GST tax transactions Assume the current GST rate is 5% Gifts & More $100 Gifts & More buys a product for resale for cash from a wholesaler for $100 What is the journal entry? Inventory $100 GST Paid $ 5 Cash $105 11

Gifts & More $200 Gifts & More sells their inventory costing $100 to a customer for $200 cash. What is the entry required? Cash $210 Revenue $200 GST Collected $ Record the sale There are 2 transactions 12

What is the second part of the entry required? Cost of Goods Sold $100 Inventory $ Record the Cost of Goods Sold

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 Summary 14 +$210 (Dr) +$200 (Cr) +$10 (Cr) +$100 (Dr) -$100 (Cr)

GST is charged on sales at all levels Gifts & More Later on, (usually the following month for large companies and quarterly for “small businesses”) Gifts & More must send the tax collected to the government 15

Gifts & More It is now time to pay the government for GST - Gifts & More pays the government the difference between GST collected $10 and GST paid $5 Gifts & More If it happens that more GST was paid than collected, the federal government would owe Gifts & More the difference What is the entry? GST Collected $10 GST Paid $5 Cash $5 16

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 17

Lets Try another Exercise together! 18

Tools Suppliers Inc. (TSI) buys products totaling $150, on account, for sale (profit) at a later time. $150 What is the journal entry? Account Title and Explanation DebitCredit Inventory$150 Accounts Payable$150 Purchased product for resale Tools Suppliers Inc. 19

Record the sales tax of $7.50 (5% of $150) owing by TSI to their supplier (on Account): $7.50 What is the journal entry? Account Title and Explanation DebitCredit Sales Tax$7.50 Accounts Payable$7.50 Sales tax owing on purchase Tools Suppliers Inc. 20

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 DebitCredit 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. 21

Here is a summary of the activities on the records of TSI: Sales Taxes DrCr 22 $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 DebitCredit Paid sales tax to government $2.50 Sales Tax $2.50 Cash$2.50 ?? Tools Suppliers Inc. 23

And now the last company in the chain of supply- Sheet Manufacturers Ltd. (SML) SML buys the product from TSI Account Title and Explanation DebitCredit $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. 24

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 DebitCredit Account Title and Explanation DebitCredit 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 government 25

And now …. Back to Paralegal Bookkeeping … 26