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How Do You Account for Sales Tax Paid on Inventory?

How Do You Account for Sales Tax Paid on Inventory

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How Do You Account for Sales Tax Paid on Inventory

Sales tax paid on inventory purchases is usually considered part of the cost of the inventory and is capitalized as such. In other words, it increases the cost of the inventory item and is not immediately expensed.

This is in accordance with the accounting principle of matching, which states that expenses should be recognized in the same period as the revenues they helped to generate. The expense for the sales tax is therefore recognized when the inventory is sold and its cost is included in Cost of Goods Sold (COGS).

Here’s an example:

Suppose your company purchases $10,000 worth of inventory, and the applicable sales tax rate is 8%. This means you will pay $800 in sales tax. Instead of recognizing this as a separate expense, you add it to the cost of the inventory, making the total inventory cost $10,800.

In your journal entry, you would debit “Inventory” for $10,800 and credit “Cash” or “Accounts Payable” (depending on whether you’ve paid the expense or not yet) for $10,800.

Later, when you sell this inventory, the cost of the inventory (including the sales tax you paid) will be transferred from “Inventory” to “Cost of Goods Sold”, matching the expense with the revenue generated by the sale of the inventory.

It’s important to note that different regions may have different tax laws and accounting treatments for sales tax, so you should consult with a tax professional or accountant for advice specific to your situation.

Example of How to Account for Sales Tax Paid on Inventory

Let’s say your company operates a retail store and you buy $50,000 worth of new inventory from a supplier. The sales tax rate in your area is 6%. This means you will pay $3,000 in sales tax ($50,000 * 6%).

Rather than accounting for this sales tax as a separate expense, you would include it in the cost of the inventory you purchased. Thus, the total cost of your inventory is $53,000 ($50,000 inventory + $3,000 sales tax).

In terms of accounting entries:

When you purchase the inventory:

  • You would debit (increase) your “Inventory” account by $53,000.
  • You would credit (decrease) your “Cash” account or credit (increase) your “Accounts Payable” account by $53,000 (depending on whether you paid cash or will pay later).

This journal entry reflects the fact that you’ve increased your inventory by $53,000 and either decreased your cash or increased your liabilities (Accounts Payable) by the same amount.

When you sell the inventory:

Suppose you sell all the inventory for $70,000. Now, the cost of the inventory, which includes the sales tax you initially paid, will be recorded as Cost of Goods Sold (COGS).

This recognizes the revenue from the sale. Next, you record the COGS:

  • You would debit (increase) your “Cost of Goods Sold” account by $53,000.
  • You would credit (decrease) your “Inventory” account by $53,000.

This recognizes the expense associated with the revenue you’ve just recorded. The $53,000 represents the cost of the inventory you’ve sold, which includes the sales tax you initially paid.

Remember that the specifics can vary based on different factors, including the nature of your business and your local tax laws. Always consult with an accounting professional for advice tailored to your unique circumstances.

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