Taxes Payable

Governments levy taxes on individuals and companies primarily to fund programs. For example, amounts received from federal income taxes are used to fund military, educational, and numerous other federal government programs. In addition to federal income taxes, there are many taxes affecting companies. For example, international companies must be aware of taxes in every country in which they do business, as well as, many states in the United States. In this chapter, the liabilities resulting from three specific taxes affecting companies will be examined: sales taxes, income taxes, and payroll taxes.
 

Sales Taxes Payable Sales taxes payable are current liabilities resulting from products and services sold to customers. Most states levy sales taxes, although they vary significantly on what is taxed and the tax rate. For example, some states tax food sold in restaurants but not in grocery stores. Other states tax products but not services. Companies selling products and services must be aware of the specific sales taxes in the states in which they operate. Companies are responsible for charging their customers the appropriate sales taxes and paying state governments. Through this process companies act as revenue collection agents for state governments.

Assume the Nicholas Corporation sells merchandise on account to its customers on November 3. The merchandise has a $1,000 sales price and the state in which the company is doing business has a 5% sales tax.

Show the effects on the company's resources and sources of resources of the November 3 sales.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

+ $1,050
accounts receivable

=

+ $50

sales taxes payable

 

 

+

+ $1,000

sales

The company's resources (assets) increased because the company received $1,050 of promises (accounts receivable) from customers. The company's liabilities increased because $50 of the accounts receivable do not belong to the company, but are owed to the state government. The company's stockholders' equity increased by the $1,000 generated by management (sales). It is important to note that while the company's resources increased by $1,050, only $1,000 belongs to the company. The other $50 is owed to the state and, thus, appears as the current liability, sales taxes payable. This $50 is a result of the company acting as a revenue collection agency for the government.

Remembering that assets increase with debits and debits equal credits, prepare the journal entry to record the November 3 sales.
 

Date

Description

Post.
Ref.

Debits

Credits

Nov. 3

Accounts Receivable

 

1,050

 

 

     Sales Taxes Payable

 

 

50

 

     Sales

 

 

1,000

 

Sales on account

 

 

 

States have payment schedules for companies to follow when paying sales taxes. Companies must pay the sales taxes by the appropriate date or be subject to penalties. For example, assume the state in which the Nicholas Corporation operates requires sales taxes to be paid by the 10th day of the month following the sales. Assume also the Nicholas Corporation charged its customers a total of $16,000 for sales taxes in November.

Show the effects on the company's resources and sources of resources of paying November's sales taxes on December 8.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

 - $16,000
cash

=

- $16,000

sales taxes payable

 

 

 

 

The payment of sales taxes reduced the company's resources (assets) and sources of resources (liabilities). As a result of paying the state, the company has $16,000 less cash but also owes the state $16,000 less. Stockholders' equity in not affected by the sales taxes payment because the resources were not used up by management, but were, in effect, paid to a creditor. The sales taxes are not an expense to the company. They are a cost to the customer, not to the company.

Remembering that assets increase with debits and debits equal credits, prepare the journal entry to record the December 8 payment.
 

Date

Description

Post.
Ref.

Debits

Credits

Dec. 8

Sales Taxes Payable

 

16,000

 

 

     Cash

 

 

16,000

 

Sales taxes payment

 

 

 


 

** You now have the background to do text exercise 10.6 and 10.7.
 

Income Taxes Payable Income taxes payable are liabilities resulting from companies having more revenues than expenses. In other words, as the name implies, income taxes are based on income. In addition to federal income taxes, many states also levy income taxes, although the rates vary from state to state. The actual income tax rates, both federal and state, are determined by tax authorities and are provided to companies for their use. Because the rates may change and their application can be quite complicated, companies use tax experts to calculate the amount of the taxes. The situation is further complicated by the fact that the accounting methods used for tax purposes may differ from the methods used in the preparation of financial statements. Remember FIFO and LIFO inventory methods from Chapter 8 and straight-line and accelerated depreciation from Chapter 9? In general, for tax purposes, income taxes to governments are determined according to governmental tax rules, while for financial statement purposes, income taxes are based on taxable income. As a result, it is very common that the amount of income taxes payable to governments in the near future differs from the income taxes expense reported on a company's income statement. Once again, remember how income tax payments could be postponed by using accelerated depreciation for tax purposes? If the amount of income taxes payable must be paid within 12 months, it is classified as a current liability called income taxes payable. If the amount of income taxes does not have to be paid within 12 months, it is classified as a long-term liability called deferred income taxes payable.

Assume the Nicholas Corporation uses accelerated depreciation for tax purposes but straight-line depreciation in its accounting records. As a result, the company calculates income taxes expense of $21,000 in its November accounting records. Using its knowledge of tax rules, the company calculates it will have to pay only $20,000 in income taxes in the next 12 months, while the other $1,000 will have to be paid sometime later.

Show the effects on the company's resources and sources of resources of the November income taxes.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

 

 

+ $20,000
income taxes payable

+ $1,000 deferred income taxes payable

 

 

+

- $21,000

income taxes expense

The company's resources (assets) do not change in November because the company does not pay the taxes until the date specified by the government. The company's liabilities increase because $21,000 is owed to the government. The $20,000 due to be paid within the next 12 months is a current liability while the $1,000 long-term liability is for payment due after 12 months. The company's stockholders' equity decreased by the full $21,000, the company's cost of governmental service used up by management in November.

Remembering that assets increase with debits and debits equal credits, prepare the journal entry to record the November income taxes.
 

Date

Description

Post.
Ref.

Debits

Credits

Nov. 30

Income Taxes Expense

 

21,000

 

 

     Income Taxes Payable

 

 

20,000

 

     Deferred Income Taxes Payable

 

 

1,000

 

November income taxes

 

 

 

The federal and state governments have payment schedules for companies to follow when paying income taxes. Companies must pay the income taxes by the appropriate date or be subject to penalties. For example, assume the Nicholas Corporation must pay its November taxes by December 15.

Show the effects on the company's resources and sources of resources of paying November's income taxes on December 13.
 

Total
Resources

=

Sources of
Borrowed
Resources

+

Sources of
Owner Invested
Resources

+

Sources of
Management Generated
Resources

Assets

=

Liabilities

+

Stockholders' Equity

 - $20,000
cash

=

- $20,000
income taxes payable

 

 

 

 

The payment of income taxes reduced the company's resources (assets) and sources of resources (liabilities). As a result of paying income taxes, the company has $20,000 less cash but also owes the government $20,000 less. Stockholders' equity was not affected by the income taxes payment because additional resources were not used up by management, but were, in effect, paid to a creditor.

Remembering that assets increase with debits and debits equal credits, prepare the journal entry to record the December 13 payment.
 

Date

Description

Post.
Ref.

Debits

Credits

Dec. 13

Income Taxes Payable

 

20,000

 

 

     Cash

 

 

20,000

 

Income taxes payment

 

 

 

** You now have the background to do text exercise 10.8, 10.9, and 10.10.

 

 

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