Sales tax

• Sales tax (also called VAT or GST) is ultimately paid by the final consumer of goods or services.
• Registered businesses act as tax collection agents for the government.
• Businesses charge output tax on sales and pay input tax on purchases.
• Businesses do not treat sales tax as income or expense — it is excluded from reported sales and
purchases.
• Periodically, businesses calculate:
- If output tax > input tax, they pay the difference to the tax authority.
- If input tax > output tax, they receive a refund.

Calculation of sales tax

• Net Selling Price = Amount recognized as sales income (excludes tax)

• Sales Tax = Added to the net price, based on a percentage
• Gross Selling Price = Total price charged to the customer (includes tax)
• The difference between net and gross is the sales tax to be paid to the tax authority

The tax rates in which the sales tax is calculated will be given in the question. Commonly used
rates are 20%, 17.5%, 15%, 10%.

Example (Using 20% Tax):

• Net Selling Price: £100

• Sales Tax (20%): £20

• Gross Price Charged to Customer: £120

• £100 goes to income, £20 is owed to the tax authority.

Sales Tax Rate Net Price Tax % Gross Price

20% 100% 20% 120%

17.5% 100% 17.5% 117.5%

15% 100% 15% 115%

10% 100% 10% 110%

Accounting entries for sales tax

Sales tax paid on purchase (Input tax)

Dr Purchases – excluding sales tax (net cost)

Dr Sales tax (sales tax)

Cr Payables/cash – including sales tax (gross cost)

Purchase account does not include sales tax because it is not an expense - can be recovered
Sales tax charged on sales (Output tax)

Dr Receivables/cash – sales price including sales tax (gross selling price)

Cr Sales – sales price excluding sales tax (net selling price)

Cr Sales tax (sales tax)

The sales account does not include sales tax because it is not income – it will be paid to the tax
authority.

Payment of output tax on sales to tax authority

Dr Sales tax

Cr cash

Receipt of input tax on purchase from tax authority

Dr Cash

Cr Sales tax

6.Inventory
Inventory in Ledger Accounts:

• Inventory is not updated daily in the ledger.

• Purchases and sales are recorded throughout the year, but the actual inventory levels
(opening and closing) are only considered at year-end.

• The change in inventory is calculated once annually to determine how much inventory was
used, which is vital for calculating Cost of Sales.

Cost of sales = Opening inventory + net purchase cost + expenses – closing inventory

Q. At the beginning of the financial year a business has $1,500 of inventory left over from the
preceding accounting period. During the year it purchases additional goods costing $21,000 and
make sales totalling $25,000. At the end of the year there are $3,000 of goods left that have not been
sold What is the gross profit for the year?

Year end inventory adjustments

 1. Inventory brought forward from previous year is assumed to have been used to generate assets
for sale. It should be removed from inventory assets and recognize as expense.
Dr Opening inventory in cost of sales
Cr Inventory assets
2. Unused inventory at end of year is removed from purchase costs and carried forward as an
asset into next year
Dr Inventory assets
Cr Closing inventory in cost of sales

Valuation of inventory

According to IAS 2 inventories, Inventory as included in SOFP at:

Expenditure incurred in
bringing the product or
service to its present
location and condition
Cost
Includes cost of
purchase, import duties,
freight and cost of
Lower of: conversion

Revenue expected to be
earned in the future when
Net realisable value
goods are sold less
selling costs

According to IAS 2, cost includes ‘all costs of purchase, costs of conversion and other costs incurred
in bringing the inventories to their current location and condition'.

Q. Cole’s business sells three products X, Y and Z. The following information was available at the year-
end:

X Y Z
$ $ $
Cost 7 10 19
Net realisable value 10 8 15
Units 100 200 300
What was the value of the closing inventory ?

Q. Storm, an entity, had 500 units of product X at 30 June 20X5. The product had been purchased at a
cost of $18 per unit and normally sells for $24 per unit. Recently, product X started to deteriorate but
can still be sold for $24 per unit, provided that some rectification work is undertaken at a cost of $3
per unit.

What was the value of closing inventory at 30 June 20X5 ?

Methods to calculate the cost of inventory

 Effect on Financials (in
Method Key Points When to Use
rising prices)

- Uses actual cost per item- Each - High-value, unique items - Most accurate
Unit Cost
unit is individually identified (e.g., cars, artwork) - Matches real costs

- First items purchased are sold - Lower CoS

first - Common for perishable or
FIFO - Higher profit
time-sensitive stock
- Closing inventory=recent costs - Higher inventory

- Uses average of all inventory - Smoothed CoS

costs - Large volumes of similar
AVCO - Smoothed profit &
items (e.g., screws, boxes)
- Can be periodic or continuous inventory values

Periodic weighted average cost

A method where the average cost per unit is calculated at the end of the accounting period.

Continuous weighted average cost

A method where the average cost per unit is recalculated immediately after every new purchase.
All subsequent sales are valued at this updated average cost.

Q. Invicta has closing inventory of 5 units at a cost of $3.50 per unit at 31 December 20X5. During the
first week of January 20X6, Invicta entered into the following transactions:

Purchases

• 2nd January – 5 units at $4.00 per unit

• 4th January – 5 units at $5.00 per unit
• 6th January – 5 units at $5.50 per unit

Invicta sold 7 units for $10.00 per unit on 5th January.

Required: (a) Calculate the value of the closing inventory at the end of the first week of trading
using the following inventory valuation methods:

A. FIFO
B. periodic weighted average cost
C. continuous weighted average cost.

Q. On 1 July 20X6 an entity, Pinto, had 10 items of inventory at a unit cost of $8.50. Pinto then made
the following purchases and sales during a six month period to 31 December 20X6:
Purchases:

Date Quantity Unit cost

14 Oct X6 15 9
22 Nov X6 25 9.2
13 Dec X6 20 9.5
Sales:

Date Quantity Unit selling price

23 Aug X6 7 12
20 Oct X6 10 12.25
30 Nov X6 15 12.5
24 Dec X6 18 113
Required: Based upon the available information, calculate the closing inventory valuation at 31
December 20X6 using:

(a) periodic weighted average cost

(b) continuous weighted average cost.