eVade, an internet retailer delivers its online-order goods to Virginia on a regular basis. In the aforementioned area, the company operates a fulfillment center. Nexus had not held in the past five years that the corporation was obligated to pay taxes to Virginia authorities. However, court decisions determined that fulfillment centers within each state constitute nexus, a situation that obligated the corporation to pay $ 50 million in principal arrears, as well as $ 4 million and $ 6 million in fines and interest, respectively. On 15th March, 2017, Virginia governor raised an amnesty which applied to eVade. The law meant a 50% waiver for the principal amount and full removal of the interest and penalties respectively. Consequently, the company took action to recognize these liabilities in its books of accounts. Several journals were raised as pointed out in the memo to come up with the trial balance and observe the eventual effect on the financial statements. Finally, the transactions affected current assets, cash and accumulated fund as seen via the entries’ effect on the taxes expense.
Unpaid Sales Tax Accounting Treatment
Accounting Standards Codification (ASC) 605 outlines accounting treatment for revenue recognition as well as related aspects like product sales and service rendering. It clearly states that recognition of revenue is effective immediately it is earned.
As at 31st December, 2016, eVade had already operated its distribution point in Virginia for 5 years. The aspect of sales tax has already been estimated by the company to amount to $ 50 million in principle tax. In addition to this is interest and penalty of $ 6 million and $ 4 million respectively.
The revenue of these sales had already been recognized as provided by ASC 605. However, the nexus rule passed by Virginia means that the entity has taxes, interest and penalty payable or accrued amounting to $ 50 million, $ 6 million and $ 4 million respectively.
ASC 740 explains that if the tax position does not relate to the current year’s ordinary income, it is discretely recorded in the current period. All taxes accrued shall be assumed as if they had been liable in the previous years and brought forward with any penalty or interest thereof. eVade has not been accounting for the Virginia sales tax. The economic nexus as applies in ASC 740 deems the firm suitable for tax liability. As such, the following journals are appropriate to record the transaction in this current financial year.
Journal 1: Unpaid Sales Tax Accounting Treatment
Date
Details
Debit
Credit
01/03/2017
Taxes payable
50,000,000
Accrued Interest on taxes payable
6,000,000
Accrued Penalty on taxes payable
4,000,000
Taxes expense
50,000,000
Interest on taxes payable expense
6,000,000
Penalty on taxes payable expense
4,000,000
To record unrecognized tax principle, penalty and interest
Effect on Financial Statements
At first, the taxes payable, accrued interest and penalty would all be liabilities in the balance sheet. Tax expense, interest expense and penalty expense would be expenses in the income statement. However, appropriate journal adjustments have to be made due to the amnesty raised before the trial balance and final accounts are concluded.
ASC 740-10 on Income Taxes provides for recognition and meaning of tax positions which directly as well as indirectly impacts on the financial statements. As such, tax position is thus evaluated on the basis of technical merits.
Amnesty Program Accounting Treatment
On 15th March, 2017, Virginia governor initiated tax amnesty schemes. This held that any registered taxpayer that voluntarily registered with respect to collecting taxes on a prospective basis will receive be accorded 50 % amnesty on unpaid taxes as well as on all unpaid penalties and/or interest. The management of eVade announced this accounting treatment formally on March 2017. On this date, the company followed ASC 740 rule that details how any interest or tax penalty have to be recognized. This leads to the following journal (50 % amnesty on $ 50 million principle tax translates to its reduction by $ 25 million).
Journal 2: Tax Amnesty Accounting Treatment
Date
Details
Debit
Credit
15/03/2017
Taxes payable
25,000,000
Accrued Interest on taxes payable
6,000,000
Accrued Penalty on taxes payable
4,000,000
Taxes expense
25,000,000
Interest on taxes payable expense
6,000,000
Penalty on taxes payable expense
4,000,000
To record 50% tax amnesty on tax principle and full amnesty on interest and penalty
Taxes payable expense and liability will reduce by 50%. Interest and penalty expense and liabilities will reduce wholly as depicted in the journal. It should be noted that the company completed the paperwork on June, 2017 but the formal announcement on March marked the recognition using accrual basis of accounting.
Settlement Accounting Tratment
On 15th June, 2017, eVade paid Virginia money amounting to $ 25million. In fact, ASC 740 further holds that a firm can never assert that because authorities never raised any disputes regarding its non-payment status, it will ride on this to avoid settling its dues. ASC 405-20 states that a firm shall settle liabilities via the means of extending assets to the creditor. In this case the creditor is the state of Virginia and the asset extended is money. Acting in accordance with the law, these transactions are effected as follows in the company’s books of accounts.
Journal 3: Tax Settlement Accounting Treatment
Date
Details
Debit
Credit
15/06/2017
Bank
25,000,000
Accrued taxes (payable)
25,000,000
To record payment of taxes payable to Virginia
From these entries, it is clear that the company has settled the accruing taxes payable. As such, these transactions will pass through the trial balance as follows before finally affecting the income statement and balance sheet in accordance with ASC 205 (presentation of financial statements).
Trial Balance Synopsis
Details
Debit
Credit
Bank
25,000,000
Taxes paid (expense)
25,000,000
Totals
25,000,000
25,000,000
The trial balance portrays that in the end, the financial statements will have only two entries affecting them. Taxes paid expense will be an expense in the income statement. This will reduce the accumulated fund amount in the income statement. Subsequently, this will affect the shareholders’ equity in the balance sheet by reducing it.
The bank, through which the Virginian dues were paid, will have its balance reduce by $ 25,000,000. The bank is a current asset under the balance sheet as ASC 205 points out. Its crediting will mean the total net worth of the company is reduced proportionately as such.
Conclusion
The nexus status declared made the company become liable to the tune of $60,000,000. However, the amnesty fully reduced tax penalty and interest. In addition, it reduced the tax principle amount by 50%, thereby making eVade reduce its liabilities to $ 25,000,000. Complying with ASC policies, the company settled this amount through its bank hence clearing the outstanding tax liability.
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