Hire Purchase, Lease, And Instalment Purchase System

Professor Vipin 2014

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Hire Purchase, Lease and Installment Purchase Systems

Concept of Hire Purchase

Purchase and sale of goods under a hire purchase system is different from cash sale and credit sale. In

case of cash sale, the buyer pays the lump sum to the seller and immediately ownership is passed along

with the goods. While in credit sale the payment is made in future. In these both cases the ownership

and possession of goods pass on the buyer. However, hire purchase system is a special system of

purchase and sale.

In hire purchase system, the buyer acquires the property by promising to pay necessary installment

payment of monthly, quarterly, half yearly or any other period. The period of payment has to be fixed

while, signing the hire sell agreement. Though, the buyer acquires the asset under hire purchase system

after signing the agreement, the title of ownership remains with vendor until the buyer squares up

his/her entire liability.

When the buyer pays the final installment and any other obligation according to hire purchase

agreement, only then the title of ownership of the goods would be transferred to hirer. If the hirer

makes default in the payment of any installment, the hire vendor has the right to re-possess the goods.

When the vendor re-possesses the goods due to the default of payment of installment, in this case the

amount already paid so far by the hirer will be forfeited.

Features Of Installment Purchase System

1. Installment purchase system is just like an outright credit sale of goods.

2. The buyer makes the payment in different installment over a period of time as agrees upon in

the agreement.

3. Under installment purchase system, the buyer gets the immediate possession as well as the

ownership of goods.

4. The seller cannot responses the good if the buyer made default in the payment of installment

but he/she can sue against the buyer for the recovery of amount due.

5. In case of default in the payment of installment, the total amount of installments already paid

by the buyer cannot be forfeited.

6. Under installment system, the buyer can sell or mortgage the goods even before clearing all the

installments.

7. Risks of goods/assets are to be borne by the buyer just after signing the agreement.

8. The buyer of the goods under installment purchase system has no right to return the goods to

the seller.



Important Terminologies Of Accounting For Hire Purchase System

1. Hire seller/Hire vendor/Owner:A person who sells the goods to the buyer under hire purchase system

is known as hire seller.

2. Hirer/Hire purchaser/Hire buyer: The person who purchase goods from hire vendor or who obtains

the goods from an owner under hire purchase agreement is known as hirer.

3. Cash price/Cash value: It is a value of goods at which the goods may be purchased by the hirer for

cash.

4. Down Payment: The initial cash payment made by the hire purchaser to the vendor at the time of

signing the hire purchase agreement is referred as down payment.

5. Hire Purchase Price: The hire purchase price includes the cash price and interest to be paid on the

future installment. It is the total sum payable by the hirer to the vendor.

6. Hire Purchase Charge: The difference between the hire purchase price and the cash price as stated in

the hire purchase agreement is known as hire purchase charge.

Form and Contents of Hire Purchase Agreements

Every hire purchase agreement should state the following:

1. The hire purchase price of the goods to which the agreement relates.

2. Cash price of such goods

3. The date on which the agreement shall be deemed to have commenced.

4. The number of installments in which the hire purchase price is to be paid, the amount of each of

those installments, the date or mode of determining the date upon which it is payable and the

person to whom and the place where it is payable.

5. The goods to which the agreement relates in a manner sufficient to identify them.

Limitation on Hire Purchase Charges

They are calculated in respect of each of the cash price instalment corresponding to each of the hire

purchase system. The statutory charges should be lower of the following two limits:

a) The amount calculated at 30% of each cash price instalment

b) The amount calculated is according to

SC is statutory charges

CI is the amount of cash price installment expressed in rupees or fraction thereof.



R is 10% or such higher rate as may be determined by the Central Government in consultation with RBI.

T is time expressed in years.

Right of the Hirer to Purchase with Rebate

The hirer may at any time by giving at least 14 days to the owner, complete the purchase of the goods.

He will have to pay or render to the owner the hire purchase price or the balance thereof as reduced by

the rebate calculated using:

Termination of Hire Purchase Agreement

The ire purchaser may at any time terminate the hire purchase agreement after giving the owner at

least 14 days notice in writng. The following provisions have been made in Hire Purchase Act:

a) Where the sum total of the amounts paid and amount due in respect of the hire purchase price

immediately before the termination exceeds one-half of the hire purchase price, the hirer shall

not be liable to pay the sum so named.

b) Where the sum total of the amounts paid and the amounts due in respect of the hire purchase

price immediately before the termination does not exceed one-half of the hire purchase price,

the hirer shall be liable to pay the difference between the said sum total and the said one-half or

the sum named in the agreement, whichever is less.

Example 1

ABC Company purchases a machine on the hire purchase system over a period of 5 years, payable by

annual installments of Rs. 10000. The vendor charges 10% per annum on the annual balances. The cash

value of the machine may be taken as the present value of the annuity of Re. 1 for 5 years at 10% per

annum. Reference to the annuity table shows that the present value of Re. 1 for five years at 10% per

annum is Rs. 3791. Calculate the cash price and the amount of interest included in each installment.

Solution 1

In this case, cash price of the asset is calculated on the basis of the present value of the annuity of one

rupee for five years at 10% which is Rs. 3791, calculated as:

Present value of Rs. 5 is Rs. 3791.

Hence the present value of Rs. 50000 will

Cash price of the machine is Rs. 37910.



Year Particulars Amount

Year 1 Cash price outstanding 37910

Add: Interest @10% pa 3791

41701

Less: 1st installment paid at end of the yr 10000

Year 2 Amount Outstanding in beginning of the yr 31701


34871

Less: 2nd installment paid at end of the yr 10000



27358

Less: 3rd installment paid at end of the yr 10000



19094




10000


Nil



Accounting Entries

Books of the Hirer (When Asset is Recorded at Full Cash Price)

Sl No Particulars

1 On Purchase of Asset

Asset Account

To Hire Vendor

(with full cash price)

2 On making cash down payment

Hire Vendor

To Cash / Bank

(with actual cash down payment)

3 For Interest Due

Interest Account

To Hire Vendor

(Interest is calculated on o/s amount when installment is due)

4 On payment of hire purchase installment

Hire Vendor

To Cash / Bank

(with amount paid)

5 For depreciation of the asset

Depreciation account

To Asset Account

(at end of the accounting period)

Books of the Hirer (When Asset is Recorded at Cash Price actually Paid)

Sl No Particulars

1 On Cash Down Payment

Asset Account

To Cash / Bank

(with amount of cash down payment)

2 On Hire purchase installment due

Asset Account

Interest Account

To Hire Vendor



(Asset account is debited, with amount of cash price in each installment. The interest on outstanding cash price is debited to the interest account)

3 On making payment of the installment

Hire Vendor

To Cash / Bank

(with amount of installment paid)

4 For depreciation of the asset

Depreciation account

To Asset Account

(Depreciation is charged on full cash price of the asset)

Sl No Particulars

1 On sale of goods under hire purchase

Hire purchaser account

To Sales Account

(with full cash price)

2 On receiving cash down payment

Cash / Bank Account

To Hire Purchaser

(with amount of cash down payment)

3 For Interest Due

Hire purchaser account

To Interest Account

(Interest is calculated when any installment becomes due on the outstanding balance in the account of the hire purchaser)

4 On getting payment of Installment

Cash / Bank Account

To Hire Purchaser

(with the amount of installment received)



Example 1

On 1st January 1992, A Ltd purchased from B Ltd five trucks under hire purchase system, Rs. 50000 being

paid on delivery and the balance in five installments of Rs. 75000 each payable annually on 31st

December. The vendor charges 5% per annum interest on yearly balances. The cash price on five trucks

was Rs. 375000.

Show how this transaction should be recorded in the books of both companies, if A ltd writes off

depreciation at 10% per annum on the written down value. Also show how the items will appear

balance sheet as on 31st December 1992.

Solution 1

Books of A (First Method)

Date Particulars Amount Date Particulars Amount

1992 Jan To B Ltd 375000

1992 Dec By Depreciation 37500

By Bal c/d 337500

375000 375000

1993 Jan To Balance b/d 337500


By Bal c/d 303750

337500 337500



By Bal c/d 273370

303750 303750



By Bal c/d 246030

273370 273370



By Bal c/d 221430

246030 246030

B Ltd


Jan-92 To Cash a/c 50000 Jan-92 By Truck a/c 375000

Dec-92 To Cash a/c 75000 Dec-92 By Interest a/c 16250

To Balance c/d 266250 (5% on 325000)



391250 391250

Dec-93 To Cash a/c 75000 Jan-93 By Bal b/d 266250

To Balance c/d 204560 Dec-93 By Interest a/c 13310

(5% on 266250) 279560 279560



(5% on 204560) 214790 214790



(5% on 204560) 146780 146780


Dec-96 By Interest a/c 3220

(5% on 204560) 75000 75000

Interest Account


Dec-92 To B ltd 16250 Dec-92 By P&L a/c 16250





Balance Sheet

Liabilities Amount Assets Amount

Trucks on Hire Purchase 375000

Less: Depreciation 37500

337500

Less: Due to B Ltd 266250 71250



Books of A (Second Method)


Jan-92 To Cash 50000 Dec-92 By Depreciation 37500

Dec-92 To Cash 58750 (10% on 375000)

By Bal c/d 71250

108750 108750

Jan-93 To Bal b/d 71250 Dec-93 By Depreciation 33750

Dec-93 To Cash 61690 (10% on 337500)

By Bal c/d 99190

132940 132940


Dec-94 To Cash 64770 (10% on 303800)

By Bal c/d 133580

163960 163960


Dec-95 To Cash 68010 (10% on 273400)

By Bal c/d 174250

201590 201590


Dec-96 To Cash 71780 (10% on 246000)

By Bal c/d 221430

246030 246030

Interest Account


Dec-92 To Cash 16250 Dec-92 By P&L a/c 16250







Balance Sheet

Liabilities Amount Assets Amount

Trucks on Hire Purchase 108750

Less: Depreciation 37500 71250

Books of B LTd


Jan-92 To Sales a/C 375000 Jan-92 By Cash 50000

Dec-92 To Interest a/c 16250 Dec-92 By Cash 75000

By Bal c/d 266250

391250

391250

Jan-93 To Bal b/d 266250 Dec-93 By Cash a/c 75000

Dec-93 To Interest a/c 13310 Dec-93 By Balance c/d 204560

279560

279560



214790

214790



146780

146780


Dec-96 To Interest a/c 3220

75000 75000

Sales Account


Dec-92 To Trading a/c 375000 Jan-92 By A ltd 375000

Interest Account


Dec-92 To P&L a/c 16250 Dec-92 By A Ltd 16250





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Hire Purchase, Lease, And Instalment Purchase System