How should the cash for the 8-10% local sales tax coming in due to be classified?
The Wrong Way: I have seen where owners or operators sometimes like to include this with the rest of their income because it makes revenue look bigger. Unfortunately, this approach will skew your real metrics. In addition to making revenue look greater than reality, it will make your Cost of Good Sold and Labor percentages look lower than they really are. Recording this way also makes your operating expenses look larger, because you’re eventually going to need to expense the same amount and pay the tax bill. You would also end up paying more for your annual business license because of inflated sales & revenue.
The Right Way: The correct way to classify sales tax proceeds is as a Liability on your Balance Sheet since this is something you have collected on behalf of the state, county, and city. This will also show what you owe at a glance rather than blending the amount into accounts payable. When you get ready to pay, simply reduce the liability. This method keeps sales tax off your Income Statement and entirely on your Balance Sheet.