HIRE PURCHASEA contract ofhire,is governed by the provisions of Chapter IX of the Indian Contract Act. It usually covers the common day finance agreements like purchase of consumer durables like Motor Vehicles, Computers, Household appliances like Televisions, Refrigerators etc.In the Industrial sector purchase of machinery etc is also financed by this method of hire purchase.The basic principle underlying the transaction is that the installment determined is taken as hire( rental) till the time the agreement envisages such payments. On determination of the said period the Hirer( Purchaser) has the option of paying a nominal amount to become the owner of the goods.

MEANINGHire purchase is a method of financing of the fixed asset to be purchased on future date. Under this method of financing, the purchase price is paid in installments. Ownership of the asset is transferred after the payment of the last installment.Features of Hire Purchase:The main features of hire purchase finance are:1. The hire purchaser becomes the owner of the asset after paying the last installment.2. Every installment is treated as hire charge for using the asset.3. Hire purchaser can use the asset right after making the agreement with the hire vendor.4. The hire vendor has the right to repossess the asset in case of difficulties in obtaining the payment of installment.The agreement contains the following:(i)The hire purchase price of the goods to which the agreement relates;(ii)The cash price of the goods, that is to say, the price at which the good is purchased for cash;(iii) The date of the commencement of the agreement;(iv) The number and time interval of installments by which the hire purchase price is to be paid;(v) The name of goods, with its sufficient identity, to which the hire purchase agreement relates to;(vi)The amount to be paid, if any, at the time of signing the agreement;(vii)The signatures of the parties involved in transaction.If the hire purchase transaction is financed by the manufacturer or dealer, then two parties, called, hire vendor and hire purchaser, are involved in the agreement. The hire purchase transaction is financed by some financial institution, and then there are three parties involved in the transaction.These are:(i) Hire Vendor,(ii) Hire Purchaser, and(iii) Financial Institution.In such case, the vendor, firstly, receives the bills of exchange for hire purchase price of the goods from the hirer. The vendor, then, discounts the bills with the financial institution and, thus, gets payment for the goods sold under hire purchase system. The financial institution collects the payments of the bills from the hirer, as and when the installments fall due.This entire process is depicted in the following Figure 20.1.

Hire-purchase transaction benefits all parties involved in it. While it increases vendors sales, it enables the hire purchaser to make use of costly machinery, equipments, etc., without making full payment on the date of signing the agreement. After making the payment of the last installment, the hire purchaser also acquires the ownership of the goods purchased under hire-purchase system.Hire Purchase:Small scale firms can acquire industrial machinery, office equipment, vehicles, etc., without making full payment through hire purchase. With the help of assets acquired through hire purchase they can produce and sell. From the earning payments can easily be made in installments. Ultimately the ownership of assets can be acquired.Now several agencies like NSIC provide machinery and equipment to small scale units on hire purchase basis and on lease basis.Advantages of Hire Purchase System:(1) Convenience in Payment:The buyer is greatly benefited as he has to make the payment in installments. This system is greatly advantageous to the people having limited income.(2) Increased Volume Of Sales:This system attracts more customers as the payment is to be made in easy installments. This leads to increased volume of sales.(3) Increased Profits:Large volume of sales ensures increased profits to the seller.(4) Encourages Savings:It encourages thrift among the buyers who are forced to save some portion of their income for the payment of the installments. This inculcates the habit to save among the people.(5) Helpful For Small Traders:This system is a blessing for the small manufacturers and traders. They can purchase machinery and other equipment on installment basis and in turn sell to the buyer charging full price.(6) Earning Of Interest:The seller gets the installment which includes original price and interest. The interest is calculated in advance and added in total installments to be paid by the buyer.(7) Lesser Risk:From the point of view of seller this system is greatly beneficial as he knows that if the buyer fails to pay one installment, he can get the article back.Disadvantages of Hire Purchase System:(1) Higher Price:A buyer has to pay higher price for the article purchased which includes cost plus interest. The rate of interest is quite high.(2) Artificial Demand:Hire purchase system creates artificial demand for the product. The buyer is tempted to purchase the products, even if he does not need or afford to buy the product.(3) Heavy Risk:The seller runs a heavy risk under such system, though he has the right to take back the articles from the defaulting customers. The second hand goods fetch little price.(4) Difficulties in Recovery of Installments:It has been observed that the sellers do not get the installments from the purchasers on time. They may choose wrong buyers which may put them in trouble. They have to waste time and incur extra expenditure for the recovery of the installments. This sometimes led to serious conflicts between the buyers and the sellers.(5) Break Up Of Families:The system puts a great financial burden on the families which cannot afford to buy costly and luxurious items. Recent studies in western countries have revealed that thousands of happy homes and families have been broken by hire purchase buyings.

DEFINITIONAsystemby which abuyerpaysfor a thing in regular installments while enjoying the use ofit.During therepaymentperiod,ownership(title) of the item does not pass to the buyer. Upon the fullpaymentof theloan, the title passes to the buyer. UK term; the usual US term isinstallment buying.

The seller and the ownerIf the seller has the resources and the legal right to sell the goods on credit (which usually depends on a licensing system in most countries), the seller and the owner will be the same person. But most sellers prefer to receive a cash payment immediately. To achieve this, the seller transfers ownership of the goods to a Finance Company, usually at a discounted price, and it is this company that hires and sells the goods to the buyer. This introduction of a third party complicates the transaction. Suppose that the seller makes false claims as to the quality and reliability of the goods that induce the buyer to "buy". In a conventional contract of sale, the seller will be liable to the buyer if these representations prove false. But, in this instance, the seller who makes the representation is not the owner who sells the goods to the buyer only after all the installments have been paid. To combat this, some jurisdictions, includingIreland, make the seller and the finance house jointly and severally liable to answer for breaches of the purchase contract.Implied warranties and conditions to protect the hirerThe extent to which buyers are protected varies from jurisdiction to jurisdiction, but the following are usually present:1. the hirer will be allowed to enjoy quiet possession of the goods, i.e. no-one will interfere with the hirer's possession during the term of this contract2. the owner will be able to passtitleto, or ownership of, the goods when the contract requires it3. that the goods are of merchantable quality and fit for their purpose, save that exclusion clauses may, to a greater or lesser extent, limit the Finance Company's liability4. where the goods are let by reference to a description or to a sample, what is actually supplied must correspond with the description and the sample.The hirer's rightsThe hirer usually has the following rights:1. To buy the goods at any time by giving notice to the owner and paying the balance of the HP price less a rebate (each jurisdiction has a different formula for calculating the amount of this rebate)2. To return the goods to the owner this is subject to the payment of a penalty to reflect the owner's loss of profit but subject to a maximum specified in each jurisdiction's law to strike a balance between the need for the buyer to minimize liability and the fact that the owner now has possession of an obsolescent asset of reduced value3. With the consent of the owner, to assign both the benefit and the burden of the contract to a third person. The owner cannot unreasonably refuse consent where the nominated third party has good credit rating4. Where the owner wrongfully repossesses the goods, either to recover the goods plus damages for loss of quiet possession or to damages representing the value of the goods lost.The hirer's obligationsThe hirer usually has the following obligations:1. to pay the hire installments2. to take reasonable care of the goods (if the hirer damages the goods by using them in a non-standard way, he or she must continue to pay the installments and, if appropriate, recompense the owner for any loss in asset value)3. to inform the owner where the goods will be kept.4. A hirer can sell the products if, and only if, he has purchased the goods finally or else not to any other third party.it is pretty much similar to installment but the main difference is of ownership.The owner's rightsThe owner usually has the right to terminate the agreement where the hirer defaults in paying the installments or breaches any of the other terms in the agreement. This entitles the owner:1. to forfeit the deposit2. to retain the installments already paid and recover the balance due3. to repossess the goods (which may have to be by application to a Court depending on the nature of the goods and the percentage of the total price paid)4. to claim damages for any loss suffered.ACCOUNTING FOR HIRE PURCHASEHire purchase is an agreement between two parties in which one party purchase any asset from other party. Because he has no money to pay, so he pays per month hire charges. Vendor has the possession of asset. When buyer pays total price of assets in the form of hire charges, then asset is transferred to its purchaser. Vendor may also transfer asset before last payment ofinstallment on his own risk. If buyer will become defaulter, vendor has right to get his asset from hire purchaser.

Accounting Methods for Hire Purchase Transaction

For accounting point of view both hire purchase and instalment payment system are same. Before accounting, we should know following things

a) Cash price is that price which will be paid if any asset is purchased on cash withoutinstallment.

b) Hire price = cash price + interest for risk of giving asset on instalment.

c) Down payment = Payment at the beginning of deal of hire purchase.There are four methods of accounting for hire purchase.

1st Method : Cash Price Method

Under cash price method, we are deal hire purchase transactions just like normal transactions. When transactions or event happen, we record them.

Journal Entries in the books of Purchaser

a) For buying assets on hire purchase

Asset on hire purchase account Dr.

Vendor account Cr.

b) For paying the down payment to vendor

Vendor account Dr

Cash/ bank

c) When Interest is Due on unpaidinstallments

Interest on Hire Purchase account Dr.

Vendor Account Cr.

d) For Instalment Payment ( Interest payment will be also included in it)

Vendor Account Dr

Cash / Bank account Cr

e) For transferring interest to profit and loss account

Profit and Loss account Dr.

Interest on hire purchase account Cr.

f) For depreciation charge

Depreciation account Dr.

Assets on hire purchase account Dr.

g) If Asset is returned

Hire Vendor account Dr.

Asset on hire purchase account Cr.

In the books of Hire Vendor

a) For giving assets on hire

Hire purchaser account Dr.

H.P. Sale Cr.

b) For down payment received

Bank account Dr.

H.P. Sales Cr.

c) For Interest receivable

Hire purchaser account Dr.

Interest account Cr.

d) Forinstallmentdue

Installmentdue account Dr.

H.P. Sales Cr.

e) Forinstallmentreceived

Bank account Dr.

Hire purchaser account Cr.

f) Forinstallmentnot due at the year

Hire purchase stock account Dr.

Trading account Cr.

g) For stock reserve

Stock Reserve account Dr.

Hire purchase stock account Cr.

Disclosure in balance sheet

Current Assets

Hire purchase debtor XXXX

2nd Method Interest Suspense Method

In this method, we openinterestsuspense account. All the interest which is not paid on hire purchase asset will go to interest suspense account. When interest will become due, interest account will be debit and interest suspense account will credit.

following entries will pass in the books of hire buyer

a) For transferring total interest payable on hire purchase deal

Interest suspense account Dr.

Hire purchase account Cr.

b) When interest is due

interest account Dr.

interest suspense account Cr.

all other entries will be same as first method.

In the books of hire vendor

a) For transferring total interest payable to interest suspense account

hire purchaser account Dr..

interest suspense account Cr.

b) when interest is due

interest suspense account Dr.

interest account Cr.

all journal entries will be same of first method

Disclosure in the balance sheet

Current Assets

Hire purchase debtors

Less balance in interest suspense account

3rd Method : Trading Method

In this method, the hire purchase trading account is prepared in the book of vendor of asset in the form of hire purchase system.

4th Method : Stock and Debtor Method

In this method, hire purchase stock, hire purchasedebtorand hire purchase adjustment account are maintained. Following entries will pass in the books of vendor

a) When goods are sold on hire purchase

hire purchase stock account Dr. ( Hire purchase price)

stock account Cr. ( Actual cost of sale of goods )

hire purchase adjustment account Cr. ( difference between hire purchase price and actual cost )

b)Wheninstallmentsbecome due for payment

hire purchase debtors account Dr.

hire purchase stockaccountCr.

c) When cash is received

Cash account Dr.

Hire purchase debtor account Cr.

d) stock reserve account on opening stock

stock reserve account Dr.

hire purchase adjustment account Cr.

e) Stock reserve on closing stock

Hire purchase adjustment account Dr.

Stock reserve account Cr.Accounting Treatment Of Hire Purchase System Or Methods Of Recording Hire Purchase TransactionsJournal Entries In TheBooksOf Hire PurchaserTherearetwomethodsof recording hire purchase transactions in the books of the hire purchaser:i. When theassetis recorded in full cashprice-:full cash price methodii. When the asset is recorded at cash price actually paid in each installment-: Actual cash pricemethod.

1. For the purchase of asset:First MethodAsset A/C (full cash price)...........Dr.To vendor A/C

Second MethodNo entry

2. For the payment made for 'down payment'First MethodVendor A/C.............Dr.To bank A/C

Second MethodAsset A/C............Dr.To Bank A/C

3. For installment dueFirst MethodInterest A/C............Dr.To vendor A/C

Second MethodAsset A/C (part of cash value)............Dr.To Interest A/C

4. For the payment of installment (both method)Vendor A/C............Dr.To Bank A/C

5. For charging depreciation( on the basis of cash value) (both methods)Depreciation A/C...................Dr.To Asset A/C

6. For transfer of interest and depreciation(both methods)Profit and loss A/C............Dr.To depreciation A/CTo interest A/C

Note:entries 3,4,5 and 6 will be repeated year after year until the final installment is paid.

Journal Entries In The Books Of Vendor

1. For selling goods on hire purchaseHire purchase A/C...........Dr.(full cash price)To sales/hire purchase sales A/C

2. For receiving down paymentCash/bank A/C.................Dr.To hire purchaser A/C

3. For installment dueHire purchaser A/C............Dr.To Interest A/C

4. For receiving the installmentCash/bank A/C .............Dr.To hire purchaser A/C

5. For transferring interestInterest A/C............Dr.To profit and loss A/C.

Note:* Depreciation will not charge by hire vendor.* Entries 3,4 and 5 will be repeated year after year until the first installment is paid.How to Calculate Interest? (4 Cases) |Hire PurchaseHire purchase problems require periodic computation of interest under any of the following cases:(1) Where Cash Price, Interest Rate and Installment are Given:Illustration:On 1st January 2003, A bought a television from a seller under Hire Purchase System, the cash price of which being Rs 10.450 as per the following terms:(a) Rs 3,000 to be paid on signing the agreement.(b) Balance to be paid in three equal installments of Rs 3,000 at the end of each year,(c) The rate of interest charged by the seller is 10% per annum.You are required to calculate the interest paid by the buyer to the seller each year.Solution:Note:1. there is no time gap between the signing of the agreement and the cash down payment of Rs 3,000 (1.1.2003). Hence no interest is calculated. The entire amount goes to reduce the cash price.2. The interest in the last installment is taken at the differential figure of Rs 285.50 (3,000 2,714.50).(2) Where Cash Price and Installments are Given but Rate of Interest is Omitted:Where the rate of interest is not given and only the cash price and the total payments under hire purchase installments are given, then the total interest paid is the difference between the cash price of the asset and the total amount paid as per the agreement. This interest amount is apportioned in the ratio of amount outstanding at the end of each period.Illustration:Mr. A bought a machine under hire purchase agreement, the cash price of the machine being Rs 18,000. As per the terms, the buyer has to pay Rs 4,000 on signing the agreement and the balance in four installments of Rs 4,000 each, payable at the end of each year. Calculate the interest chargeable at the end of each year.

(3) Where installments and Rate of Interest are Given but Cash Value of the Asset is Omitted:In certain problems, the cash price is not given. It is necessary that we must first find out the cash price and interest included in the installments. The asset account is to be debited with the actual price of the asset. Under such situations, i.e. in the absence of cash price, the interest is calculated from the last year.It may be noted that the amount of interest goes on increasing from 3rd year to 2nd year, 2nd year to 1st year. Since the interest is included in the installments and by knowing the rate of interest, we can find out the cash price.Thus:Let the cash price outstanding be: Rs 100Interest @ 10% on Rs 100 for a year: Rs 10Installment paid at the end of the year 110The interest on installment price = 10/110 or 1/11 as a ratio.Illustration:I buy a television on Hire Purchase System.The terms of payment are as follows:Rs 2,000 to be paid on signing the agreement;Rs 2,800 at the end of the first year;Rs 2,600 at the end of the second year;Rs 2,400 at the end of the third year;Rs 2,200 at the end of the fourth year.If interest is charged at the rate of 10% p.a., what was the cash value of the television?Solution:

(4) Calculation of Cash Price when Reference to Annuity Table, the Rate of Interest and Installments are Given:Sometimes in the problem a reference to annuity table wherein present value of the annuity for a number of years at a certain rate of interest is given. In such cases the cash price is calculated by multiplying the amount of installment and adding the product to the initial payment.Illustration:A agrees to purchase a machine from a seller under Hire Purchase System by annual installment of Rs 10,000 over a period of 5 years. The seller charges interest at 4% p.a. on yearly balance.N.B. The present value of Re 1 p.a. for five years at 4% is Rs 4.4518. Find out the cash price of the machine.Solution:Installment Re 1 Present value = Rs 4.4518Installment = Rs 10,000 Present value = Rs 4.4518 x 10,000 = Rs 44,518

Accounting Record in the Books of Hire Purchaser (2 Methods)There are two methods of making accounting record in the books of Hire Purchaser:First Method (Capitalizing Only the Portion of Cash Price Paid):Under this method, the asset account is debited with the cash price included in each installment. Remember, the down payment is fully towards cash price. As and when he pays the instalment, he capitalises the amount equal to the cash price of the instalment. The buyer recognises the fact that no legal title to the goods passes to him until the last instalment is paid.Here it is important to note that the hire purchaser debits the asset account with the cash price as and when he pays the instalment under gradual capitalisation method. That is, when he pays the instalment, he capitalises the amount equal to the cash price of the instalment. At the same time, he is permitted to use the asset, as he is the true owner even before the last payment. Therefore, it is appropriate to bring depreciation of the asset on its full cash price.

The last four entries are repeated year after year till the last instalment is paid off.Second Method (Capitalising the Full Cash Price):Under this method, the hire purchaser debits the asset account at its full cash price and credits the hire vendors account. Many hire purchasers enter into the hire purchase agreement with the intention of honouring them.The following journal entries will clarify:

N.B. The last four entries are repeated year after year till the last instalment is paid off.Illustration:Mr. Ramprasad purchased under hire purchase system a machine from Bombay Company on 1st January 2003, paying cash Rs 10,000 and agreeing to pay three further instalments of Rs 10,000 each on 31st December every year.The cash price of the machine is Rs 37,250 and Bombay Company charges interest at 5% p.a. Ramprasad writes off depreciation at the rate of 10% p.a. on diminishing balance method.Journalise these transactions and open ledger accounts in the books of Ramprasad, under both the methods.

Entries in the Books of Hire Vendor (With Specimen)Accounting Records in the Books of Hire Vendor (With Specimen & Illustration)!The property in the goods does not pass from the Hire Vendor to the Hire Purchaser, under hire purchase system, until the payment of last instalment is paid off. But in actual practice, the Hire Vendor treats the sales as ordinary sales.Entries in the Books of Hire Vendor:Thus, the Hire Vendor makes the entries as under:1. Hire Purchaser Account Dr.To Hire Sales(Being the entry for sales under hire purchase system)2. Bank Account Dr.To Hire Purchaser A/c(Being the payment of down payment)At the end of the first year:3. Hire Purchaser Account Dr.To Interest Account(Being interest due on unpaid balance)4. Bank Account Dr.To Hire Purchaser A/c(Being amount of instalment received)5. Interest Account Dr.To Profit & Loss A/c(Being transfer of interest)6. Hire Sales Account Dr.To Trading Account(Being hire sales transferred to Trading Account)Note: No entry for depreciation is made in the books of the Hire Vendor. Entries 3, 4 and 5 will be repeated in all subsequent years.Illustration:On 1st January 2003 Gopal bought a machine from Ram & Co. on hire purchase system, the cash price of the machine being Rs 35.775, under the following terms:(a) Rs 10,000 payable on signing of the agreement i.e. 1.1.2003.(b) Remaining balance to be paid in three equal instalments of Rs 10,000 each at the end of the subsequent years.(c) Interest to be charged at the rate of 8%.(d) Depreciation to be provided at 10% annually.Make necessary entries in the books of both the parties and show the ledger accounts too.Solution: