accounting for sales tax - institute for …€¦ · understand basic accounting principles related...

ACCOUNTING FOR SALES TAX PROFESSIONALS

Suzanne Wilson Sr. Mgr. – Transaction Tax American Airlines Phoenix, AZ [email protected]

Jeff McGhehey, CMI Sr. Mgr. – Indirect Tax The Home Depot Atlanta, GA [email protected] IP

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IPT 2014 ANNUAL CONFERENCE

Understand how sales and use taxes impact the financial statements

Understand basic accounting principles related to sales tax collection and use tax accrual

Review typical accounting entries to record sales tax and use tax transactions

Review the sales and use tax reconciliation process

Understand how reserves are used to estimate and record audit liabilities

LEARNING OBJECTIVES

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Understand how sales and use taxes impact the financial statements

Sales and use taxes may have a material impact on a

company’s financial statements, so understanding how they impact the balance sheet and income statements is vital.

Awareness of how sales/use taxes impact your income statement will help you be a better partner with the operational side of your business.

SALES/USE TAX & FINANCIAL STATEMENTS

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Sales and use taxes transactions may impact either the balance sheet or income statement or both.

Balance Sheet Sales tax (accruals and payments) Use tax (accruals and payments) Use tax (accrued on asset purchases) Audit reserves

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Income Statement Sales tax (tax expense) Vendor paid tax typically follows accounting of underlying

transaction

Use tax (tax expense) Accrued use tax on expense payables typically follows accounting

of underlying transaction

Audit reserves

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Understand basic accounting principles related to sales tax collection and use tax

accrual

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BASIC ACCOUNTING PRINCIPLES


Sales tax is imposed on the sale or lease of goods and services and is collected at the time of sale.

States imposing sales tax also impose a use tax,

sometimes called a compensating use tax, on buyers of TPP where sales tax is not paid.

Sales and use tax together provide a uniform tax

upon either the sale or use to TPP irrespective of where it was purchased.

SALES TAX VS USE TAX

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Sales taxes are collected by vendors in most states. Some states impose a sellers use tax. This tax is

collected by a vendor making retail sales in a state they are not physically located in but have nexus.

Use taxes are self assessed by the purchaser. When a company bills its customers for sales taxes,

those taxes are not an expense to the company; they are an expense to the customer.

When a company accrues use tax on purchases,

those taxes are an expense to the company.


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It is common to have separate sales tax liability accounts for each state. If a company operates in multiple states, having a

separate account for each of the sales tax collected makes it much easier to pay remittances. It also reduces the work required to justify the company’s

remittance in a sales tax audit.


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When you bill a customer for sales tax, the journal entry is a debit to the accounts receivable asset for the entire amount of the invoice, a credit to the sales account for that portion of the invoices attributable to the goods or services billed, and a credit to the sales tax liability account for the amount of sales tax billed.

SALES TAX COLLECTION

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Record July 1 sale and 6% sales tax liability

RECORDING SALES TAX COLLECTION

General Journal J1

Date Account Titles and Explanation Ref. Debit Credit Jul. 1 Accounts Receivable 1060.00

Sales 1000.00 Sales Tax Liability 60.00 (Record day's sales and sales tax liability)

Total debits must always equal total credits 1060.00 1060.00

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At the end of the month (or longer, depending on your remittance arrangement), you fill out a sales tax remittance form that itemizes sales and sales taxes, and send the government the amount of the sales tax recorded in the sales tax liability account.

This remittance may take place before the customer has paid you for the sales tax (credit transactions)

SALES TAX REMITTANCE

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Record July sales tax liability paid

REMITTING SALES TAX COLLECTED

General Journal J2

Date Account Titles and Explanation Ref. Debit Credit Aug 20 July Sales Tax Liability 60.00

Cash 60.00 (Record July’s sales tax liability remitted)


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If you file and pay your sales tax return on a timely basis, some states allow you to keep a portion of the sales tax as a discount.

The amount of the discount varies and is, most often, a percentage of the sales tax collected.

RECORD ACCOUNTS RECEIVABLE COLLECTION

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Record July sales tax liability paid with discount

REMITTING SALES TAX COLLECTED

General Journal J2

Date Account Titles and Explanation Ref. Debit Credit Aug 20 July Sales Tax Liability 60.00

Discounts .60 Cash 59.40

(Record July’s sales tax liability remitted)


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When the customer pays you for the invoice, you debit the cash account for the amount of the payment and credit the accounts receivable account.


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Record accounts receivable invoice paid


General Journal J3

Date Account Titles and Explanation Ref. Debit Credit Aug 1 Cash 1060.00

Accounts Receivable 1060.00 (Record accounts receivable invoice paid)


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What if the customer does not pay the sales tax portion of the invoice? In that case, you issue a credit memo that

reverses the amount of the sales tax liability account (and which is also a reduction of the accounts receivable asset account). It is quite likely that you will have already

remitted this sales tax to the government, so the customer's non-payment becomes a reduction in your next sales tax remittance to the government.

CREDITING SALES TAX CHARGED

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Credit sales tax charged on invoice

RECORDING SALES TAX COLLECTION

General Journal CM1

Date Account Titles and Explanation Ref. Debit Credit Jul 31 Sales Tax Liability 10.00

Accounts Receivable 10.00 (Record credit sales tax liability)


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Use tax is assessed upon TPP purchased by a business of the assessing state for use, storage, or consumption in that state (not for resale), regardless of where the purchase took place.

Use tax applies when a business purchases an item that does not include sales tax. Usually, this is due to out-of-state purchases or purchases over the internet.

The use tax is typically assessed at the same rate as the sales tax that would have been owed had the same goods been purchased in the state of residence.

USE TAX ACCRUAL

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Not all use tax derives from sales transactions. There are also internal transactions a company might initiate that will trigger use tax consequences.

For example, ABC Furniture Company buys its

inventory tax-free with a resale certificate, then charges sales tax to its customers. But if this company removes furniture from inventory for its own use, it has triggered a tax incident: use tax is due on the converted inventory that is being used, not sold.

USE TAX ACCRUAL

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Record July 1 use tax liability

RECORDING USE TAX LIABILITY

General Journal J4

Date Account Titles and Explanation Ref. Debit Credit Jul. 1 Inventory 1000.00

Inventory – use tax 60.00 Office Supplies 1000.00 Office Supplies – use tax 60.00

Cash 2000.00 Use Tax Liability 120.00 (Record use tax liability on purchases)


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Record July use tax liability paid

REMITTING USE TAX LIABILITY

General Journal J5

Date Account Titles and Explanation Ref. Debit Credit Aug 20 July Use Tax Liability 120.00

Cash 120.00 (Record July’s sales tax liability remitted)


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Definition: “Reconciliation” is the process of comparing

information that exists in two systems or locations, analyzing differences and making corrections so that the information is accurate, complete and consistent in both locations.

THE SALES AND USE TAX RECONCILIATION PROCESS

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Balance sheet accounts must be reconciled on a periodic and timely basis to verify that all items were correctly posted to the account.

Sales tax liability accounts are often subject to

Section 404 of the Sarbanes-Oxley Act (SOX). The reconciliation may be one of the tests to establish that

the control has sufficient internal controls around financial reporting.

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THE SALES AND USE TAX RECONCILIATION PROCESS


Steps for monthly reconciliation: 1. Begin with verifying the opening balance in the

G/L for the month 2. Review the sales tax activity posted to the

account to ensure that items are properly classified

3. Review all payments posted to the account are properly classified

4. Confirm the ending balance per the reconciliation agrees to the general ledger balance

SALES TAX RECONCILIATION

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Date Description Debit (Credit) Balance

July 1 Balance Forward (43,000)

July 20 Payment June Liability 43,000 0

July 31 July Sales Tax Collected (35,000) (35,000)

Aug 20 Payment July Liability 35,000 0

SALES TAX RECONCILIATION PROCESS

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Date Description Debit (Credit) Balance

July 1 Balance Forward (25,000)

July 20 Payment June Liability 25,000 0

July 10 Prepayment #1 of July Liability 15,000 15,000

July 20 Prepayment #2 of July Liability 15,000 30,000

July 31 July Sales Tax Collected (23,000) 7,000

G/L Balance consists of:

Credit from overpayment on July Return (apply to Aug. return)

7,000

SALES TAX RECONCILIATION PROCESS

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SAMPLE BALANCE SHEET ABC Manufacturing, Inc.

Balance Sheet July 31, 2013

Cash $ 2,000 Accounts Receivable 2,106 Office Equipment $ 5,000 Less: Accumulated Depreciation 2,000 3,000 Total Assets $ 7,106

Liabilities and Owner’s Equity Liabilities Accounts Payable $ 500 Sales Tax Payable 6 Total Liabilities 506 Owner’s Equity Common stock 5,000 Retain earnings 1,600 Total liabilities and owner’s equity $ 7,106

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FAS 5 / ASC 450 - Accounting for Contingencies A “contingency” is an existing condition, situation,

or set of circumstances involving uncertainty as to possible gain or loss that will ultimately be resolved when one or more future events occur or fail to occur.

A “liability” is a known obligation. Indirect taxes tend to be liabilities rather than

contingencies

RESERVES FOR AUDIT LIABILITY

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A “contingency” exists if the loss is either: “Probable” (more than 65-75% likely to occur); or “Reasonably estimable”

If both conditions apply, then the “contingency” has become a “liability” and must be recognized in the financial statements.

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Common reasons for contingencies or liabilities. Nexus Audit assessments Tax Matrix Errors Exemption Certificates Use tax accrual procedures Unusual transactions

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Initially, a sales and use tax audit may be

considered a contingency, assuming no issues are known at the outset of the audit.

If issues are known to exist, then a liability

should be recorded in the financial statements. For example, a prior audit in the same jurisdiction or

knowledge of existing exposure; and the amounts are “probable and estimable”.

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Estimating a liability: Audits Prior audit experience Average percentage error of expense payables Average percentage error of exempt sales Exempt Customers Non-taxable Items

Short tests of current audit period

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Should the audit results in one state provide insight into the audit reserves in another jurisdiction? Generally speaking, yes.

Consider your industry and business practices in states where you do business. Are they consistent or are they unique from

state to state? Consider your accounting systems and your

processes. Are they automated or manual?

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Entry to record liability

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General Journal J5 Date Account Titles and Explanation Ref. Debit Credit

8/31 Tax Expense (Income Statement) 152,000

Accrued Tax Liability (Balance Sheet) 122,000

Accrued Interest Liability (Balance Sheet) 30,000

(Record August Sales Tax Reserves)

Total debits must always equal total credits 152,000 152,000


Entry to record payment of audit and release of excess reserves

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General Journal J5 Date Account Titles and Explanation Ref. Debit Credit

12/15 Accrued Tax Liability (Balance Sheet) 127,000

Accrued Interest Liability (Balance Sheet) 22,000

Other Income (Income Statement) 3,000

Cash (Balance Sheet) 149,000 (Pay Sales Tax Audit Liability)

Total debits must always equal total credits 152,000 152,000


Best Practices: There is no such thing as a “good” surprise. Keep management informed of both “good” and “bad”. Document your positions. Whether or not you accrue a

liability, your financial statement auditors may request documentation to establish the reasonableness of your decisions and estimates.

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Questions

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IPT ANNUAL CONFERENCE

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