Hire Purchase Accounting, How It Differs From Installments system And Its Accounting Entries

Hire Purchase Accounting

Introduction

Buying and selling of goods as for the system of hire purchase is different from the cash sales and credit sales. As for cash sales, the buyer pays a sum to the seller and the ownership is immediately passed along with the goods while as for credit sale, the payment is made in future. In the two cases the ownership of goods pass on the buyer.

However, hire purchase system is a special system of transaction. In hire purchase system, the buyer obtains the asset by promising to pay necessary installment payments periodically. Although the buyer obtains the property via the system of hire purchase after signing the agreement, the ownership title still stays with the vendor until the buyer settles his entire liability.

When the buyer pays up the final installment, only then the ownership title and possession of the goods would be transferred to buyer. If the buyer makes default in the payment of the installments, the seller can to re-possess the assets. When the seller re-possesses the goods due to the default of installment payment, in this case the amount already paid by the buyer will be lost and capitulated.

The HP price of goods is generally more than their outright price because it includes interest together with the cash price. Under this hire purchase system, the vendor shall repair the goods which are in possession of the hirer on the condition that the hirer takes the proper care of the goods obtained. The risk is also borne by the seller until the payment of last installment.

Some important terminologies In Hire Purchase Accounting

1. Hire Seller or Hire Vendor: The seller of goods in hire purchase is the one referred to as Hire vendor.

2. Hirer or Hire Purchaser or Hire Buyer: The purchaser of asset from hire vendor under hire purchase agreement is called hirer or hire purchaser.

3. Cash Value or Cash price: It is a value at which the asset may be purchased by the buyer 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: This is the difference between the HP Price and the cash price as stated in the agreement of hire purchase.

 

differences between hire purchase and installment

1.  Nature Of Contract
   In Hire Purchase System, It is a hiring goods agreement while In Installment Payment, It is an agreement of sale.
   
   2. Ownership
   In Hire Purchase System, ownership of asset is only transferred after the payment of the final installment while In Installment Payment, ownership of the asset is passed to the buyer immediately after signing the agreement.
   
   3. Right
   In Hire Purchase System, the buyer can not resell, destroy or transfer the goods while In Installment Payment, the buyer can resell, mortgage, destroy or transfer as his own wish.
   
   4. Risk
   In Hire Purchase System, all risks are borne by the HP vendor before the payment of the final installment while In Installment System, all the risks are borne by the buyer right from the date of agreement. 
   
   5. Right Of Return
   In Hire Purchase System, the buyer can return the asset before  the payment of the final installment while In Installment Payment, the buyer cannot return the assets to the seller.
   
   6. Repair And Maintenance
   In Hire Purchase System, the liability of maintenance and repair lies with the HP vendor on the condition  that the buyer takes the utmost good care of the asset while In Installment Payment, the liability of  repair and maintenance lies with the buyer.
   
   7. Forfeiture Of Installment Paid
   In Hire Purchase System, in case of default in payment of installment, already paid installments will be forfeited and  therefore be treated as hire charges. While In Installment Payment, There is nothing like forfeiture.

ACCOUNTING TREATMENT OF HIRER PURCHASE

Journal Entries In The Books Of The Hire Purchaser

We have two methods of recording transactions involving hire purchase in the books of the hire purchaser:

1. Full cash price method: When the asset is recorded in full cash price.

2. Actual cash price method: When the asset is recorded at cash price actually paid in each installment.

i. For the purchase of asset:

First Method

Debit Asset A/C (full cash price)

To vendor A/C

Second Method

no entry

ii. For the payment made for 'down payment'

First Method

Debit Vendor A/C

To bank A/C

Second Method

Debit Asset A/C

To Bank A/C

iii. For installment due

First Method

Debit Interest A/C

To vendor A/C

Second Method

Debit Asset A/C (part of cash value)

To Interest A/C

iv. For the payment of installment (using both method)

Debit Vendor A/C

To Bank A/C

v. For charging depreciation (on the basis of cash value using both methods)

Debit Depreciation A/C

To Asset A/C

vi. For transfer of interest and depreciation (using both methods)

Debit Profit and loss A/C

To depreciation A/C

To interest A/C

Note that: entries in No. iii, iv, v and vi are to be repeated yearly until the final installment is paid.

Journal Entries In The Books Of Hire Purchase Vendor

i. For selling goods on hire purchase

Debit Hire purchase A/C with the full cash price

To sales/hire purchase sales A/C

ii. For receiving down payment

Debit Cash/bank A/C (depending on how the payment was received)

To hire purchaser A/C

iii. For installment due

Debit Hire purchaser A/C

To Interest A/C

iv. For receiving the installment

Debit Cash/bank A/C

To hire purchaser A/C

v. For transferring interest

Debit Interest A/C

To profit and loss A/C.

Note that: Depreciation will not be charged by hire vendor.

Entries No. iii, iv and v are to be repeated yearly until the final installment is paid.