Financial Accounting - Hire Purchase Accounts

Financial Accounting

Hire Purchase Accounts

 

Part A: Discussion of basic theories along with necessary computation formats for calculating periodical interests, cash price, instalments, etc. and, of course, relevant journal entries to be made in the books of both Hire Purchaser and Hire Vendor under different accounting methods.

 

Part B: Eight Illustrations with Solutions.

Part A

What is hire purchase system?

When a person is unable to acquire an asset against immediate cash payment, or is not in a position to make the payment within a stipulated period of time, he may make some arrangements with the seller to make the payment in different instalments over an agreed period of time. This enables the purchaser to use the asset while paying the instalments. This type of business arrangement is known as hire purchase system.

 

Under the hire purchase system the customer (called the Hire Purchaser) obtains possession of the goods at the outset and can use it while paying for it by instalments over an agreed period of time. However, the ownership of the goods remains with the seller (called the Hire Vendor) until the hire purchaser has paid all the instalments. Each instalment paid by the hire purchaser is treated as hire charge for using the asset. In case he fails to pay any of the instalments (even the last instalment) the hire vendor will have the rights to take back his goods without compensating the hire purchaser in any manner.

 

Features of the hire purchase system

The important features of the hire purchase system can be stated as follows:

1.             The hire vendor transfers only possession of the goods to the hire purchaser immediately after the contract for hire purchase is made.

2.             The goods are physically delivered by the hire vendor on the condition that the hire purchaser would pay the agreed amount (i.e. the Hire Purchase Price) by a number of instalments over an     agreed period of time.

3.             The hire purchaser generally makes an initial payment (called Down Payment) on signing the agreement and the balance of the hire purchase price is paid in instalments at regular intervals    over a specified period of time.

4.             Each instalment including the down payment is treated as hire charge by the hire vendor.

5.             Each instalment includes an interest on the unpaid balance of the Cash Price (i.e. the price at which the goods are sold on cash basis against full payment).

6.             The property in goods (i.e. the ownership of the goods) is passed on to the hire purchaser on the payment of the last instalment of the hire purchase price.

7.             The hire purchaser has the right to terminate the hire purchase agreement at any time before the property in goods is passed on from the hire vendor.

8.             In case of default in respect of payment of even the last instalment, the hire vendor has the right to take the goods back without making any compensation to the hire purchaser.

 

Important Terms

1.  Cost Price of Goods Sold on Hire Purchase

It is the price at which the hire vendor buys goods either from the manufacturers directly or from the wholesalers.

 2. Cash Price

It is the price at which the goods are sold on cash basis i.e. not on hire purchase basis. Therefore,

Cash Price = Cost Price + Profit.

 3. Hire Purchase Price

It is the price at which the goods are sold on hire purchase basis. Hire purchase price is higher than the cash price, the extra charge being the interest on delayed payments of instalments. Therefore,

Hire Purchase Price = Cash Price + Interest.

 4. Down Payment and Instalment Payment

Down payment is the part payment out of the total hire purchase price made initially at the time of signing the hire purchase agreement.

 

Instalment payments are payments which are made in equal amounts periodically to pay off the balance of hire purchase price after the down payment is made.

 

Therefore, it can be said that ─

Hire Purchase Price = Down Payment + Total of all the Instalment Payments.

 

Interest calculation format

 

Click here for Interest Calculation Format

 

 

Journal entries in the books of the hire purchaser

CASH PRICE METHOD

Date	Particulars		Debit (Rs)	Credit (Rs)
1	Asset A/c	Dr
	To Hire Vendor A/c
	(Full cash price)
2	Hire Vendor A/c	Dr
	To Bank A/c
	(Down payment)
3	Interest A/c	Dr
	To Hire Vendor A/c
	(Interest on outstanding balance of cash price)
4	Hire Vendor A/c	Dr
	To Bank A/c
	(Amount of instalment)
5	Depreciation A/c	Dr
	To Asset A/c
	(Calculated on cash price)
6	Profit and loss A/c	Dr
	To Interest A/c
	To Depreciation A/c
	(Interest and depreciation transferred to P/L A/c)

 

 

INTEREST SUSPENSE METHOD

Date	Particulars		Debit (Rs)	Credit (Rs)
1	Asset A/c	Dr
	To Hire Vendor A/c
	(Full cash price)
2	HP Int. Suspense A/c	Dr
	To Hire Vendor A/c
	(Total interest)
3	Hire Vendor A/c	Dr
	To Bank A/c
	(Down payment)
4	Interest A/c	Dr
	To HP Int. suspense A/c
	(Interest on outstanding balance of cash price)
5	Hire Vendor A/c	Dr
	To Bank A/c
	(Amount of instalment)
6	Depreciation A/c	Dr
	To Asset A/c
	(Calculated on cash price)
7	Profit and loss A/c	Dr
	To Interest A/c
	To Depreciation A/c
	(Interest and depreciation transferred to P/L A/c)

 

Journal entries in the books of the hire vendor

SALES METHOD

Date	Particulars		Debit (Rs)	Credit (Rs)
1	Hire Purchaser A/c	Dr
	To H. P. Sales A/c
	(Full cash price)
2	Bank A/c	Dr
	To Hire Purchaser A/c
	(Down payment)
3	Hire Purchaser A/c	Dr
	To Interest A/c
	(Interest on outstanding balance of cash price)
4	Bank A/c	Dr
	To Hire Purchaser A/c
	(Amount of instalment)
5	Interest A/c	Dr
	To P/L A/c
	(Interest transferred to Profit and Loss A/c)
6	H. P. Sales A/c	Dr
	To Trading A/c
	(H. P. Sales transferred to trading A/c)

 

 

INTEREST SUSPENSE METHOD

Date	Particulars		Debit (Rs)	Credit (Rs)
1	Hire Purchaser A/c	Dr
	To H. P. Sales A/c
	(Full cash price)
2	Hire Purchaser A/c	Dr
	To Int. Suspense A/c
	(Total interest)
3	Bank A/c	Dr
	To Hire Purchaser A/c
	(Down payment)
4	Int. Suspense A/c	Dr
	To Interest A/c
	(Interest on outstanding balance of cash price)
5	Bank A/c	Dr
	To Hire Purchaser A/c
	(Amount of instalment)
6	Interest A/c	Dr
	To Profit and loss A/c
	(Interest transferred to Profit and Loss A/c)
7	H. P. Sales A/c	Dr
	To Trading A/c
	(H. P. Sales transferred to trading A/c)

 

 

Repossession of goods

 

Repossession of goods by the hire vendor may be a complete repossession or a partial repossession.

 

Complete repossession

 

Journal entries in the books of the hire purchaser

Over and above the normal journal entries as shown above following additional journal entries are made when the goods are repossessed by the hire vendor:

Date	Particulars		Debit (Rs)	Credit (Rs)
1	Hire Vendor A/c	Dr
	To Asset A/c
	(H. P. asset is taken back and the account of the hire vendor is closed by transferring the balance of Hire Vendor A/c to Asset A/c)
2	Profit and loss A/c	Dr
	To Asset A/c
	(Loss due to repossession suffered by the hire purchaser)
3	Asset A/c	Dr
	To Profit and loss A/c
	(Profit due to repossession made by the hire purchaser)

 

Important note:

The hire vendor’s account has to be closed first and then the asset account has to be closed.

Journal entries in the books of the hire vendor

Over and above the normal journal entries as shown above following additional journal entries are made when the goods are repossessed by the hire vendor:

Date	Particulars		Debit (Rs)	Credit (Rs)
1	Goods repossessed A/c	Dr
	To Hire Purchaser A/c
	(Goods are repossessed and the account of the hire purchaser is closed by transferring the balance of Hire Purchaser A/c to Goods Repossessed A/c)
2	Goods repossessed A/c	Dr
	To Bank A/c
	(Expenses for repairing and reconditioning the repossessed goods)
3	Bank A/c	Dr
	To Goods repossessed
	(Repossessed goods are sold)
4	Profit and loss A/c	Dr
	To Goods repossessed
	(Loss on sale of repossessed goods transferred to P/L A/c)
5	Goods repossessed A/c	Dr
	To Profit and loss A/c
	(Profit on sale of repossessed goods transferred to P/L A/c)

 

 

Partial repossession

Journal entries for partial repossession of goods by the hire vendor are same as shown above in case of complete repossession. The only few differences between complete repossession and partial repossession, from accounting point of view, are as follows:

            i.            In case of partial repossession, neither party closes the account of the other in their respective      books;

          ii.            The goods are repossessed at a mutually agreed value (usually, based on an enhanced rate of depreciation, so far as the books of the hire purchaser is concerned);

       iii.            If the repossessed value of the goods is less than the book value (so far as the books of the hire purchaser is concerned), the difference is charged to the profit and loss account as loss on surrender in the books of the hire purchaser by debiting profit and loss account and crediting the asset account.

Part B

Financial Accounting

Hire Purchase Accounts

Selected Problems

 

Illustration: 1

Cash price of a machine is Rs 20, 00,000. Hire purchaser agrees to pay 20% down payment and balance in 4 equal annual instalments along with 12% interest per annum on balance amounts. Compute the hire purchase price of the machine showing the values of different instalments and interests included therein. Instalments are payable at the end of each year whereas the down payment is payable on signing the Hire Purchase Agreement.

 

Click here for Solution: 1 in PDF

Illustration: 2

SDF Limited purchased a machine on hire purchase basis from Ideal Machinery Company Limited on the following terms:

(a)           Cash price Rs 5, 50,000;

(b)           Down payment at the time of signing the agreement on 1.1.2010 Rs 1, 70,900;

(c)           5 annual instalments of Rs 1, 00,000 each, the first becoming due at the end of 12 months from the date of down payment;

(d)           Rate of interest is 10% per annum.

Calculate the total interest, and interest included in each of the cash instalments.

 

Click here for Solution: 2 in PDF

Illustration: 3

X purchased a T.V on hire purchase system. As per terms of the hire purchase agreement he is required to pay Rs 3000 as down payment, Rs 4000 at the end of first year, Rs 3000 at the end of second year, and Rs 5000 at end of third year. Interest is charged at 12% p.a. You are required to calculate total cash price of T.V and interest paid with each instalment.

 

Click here for Solution: 3 in PDF

Illustration: 4

X & Co. purchased a Motor car on April 1, 2009 on hire purchase paying Rs 60,000 cash down and balance in four annual instalments of Rs 55,000, Rs 50,000, Rs 45,000 and Rs 40,000 each instalment comprising equal amount of cash price at the end of each accounting period. You are required to calculate total cash price and amount of interest in each Instalment.

 

Click here for Solution: 4 in PDF

Illustration: 5

On 1.1.2010 X purchased a plant from Y on hire purchase system. The hire purchase price was settled at Rs 60,000, payable as to Rs 15,000 on 1.1.2010 and Rs 15,000 at the end of three successive years. Interest was charged @5% p.a. The asset was to be depreciated in the books of the purchaser at 10% p.a. on Reducing Balance Method. Given the present value of an annuity of Re. 1 p.a. for three years @5% interest is Rs 2.7232. Ascertain the cash price.

 

Click here for Solution: 5 in PDF

Illustration: 6

On 1.1.2015 X Ltd. took delivery from Y Ltd. of 5 machines on a hire purchase system, Rs 4,000 being paid on delivery and the balance in five instalments of Rs 6,000 each, payable annually on 31st December. The vendor company charges interest on yearly balances @ 5% p.a. The cash price of 5 machines was Rs 30,000. Show the Assets Account and Y Ltd. Account for 5 years in the books of X Ltd. Assume that the hire purchaser charges depreciation @ 20% on straight line method.

Click here for Solution: 6 in PDF

 

Illustration: 7

On 1.1.2011, A purchased 5 Machines from B. Payment was to be made — 20% down and the balance in four annual instalments of Rs 2,80,000, Rs 2,60,000, Rs 2,40,000 and Rs 2,20,000 commencing from 31.12.2011. The vendor charged interest @ 10% p.a. Mr. A writes off depreciation every year @ 20% p.a. on the original cost. On A’s failure to pay the instalment due on 31.12.2012, B repossessed all the machines on 01.01.2013 and valued them on the basis of 40% p.a. depreciation on W.D.V. basis. B after incurring Rs 6,000 on repairs sold the machines for Rs 2, 66,000 on 30.06.2013. Prepare the relevant accounts in the books of A and B.

 

Click here for Solution: 7a in PDF

Click here for Solution: 7b in PDF

Click here for Solution: 7c in PDF

Illustration: 8

On 1.1.2011, Mr. A purchased 5 Machines from Mr B. Payment was to be made—20% down and the balance in four annual instalments of Rs 2,80,000, Rs 2,60,000, Rs 2,40,000 and Rs 2,20,000 commencing from 31.12.2011. The vendor charged interest @ 10% p.a. Mr. A writes off depreciation @ 20% p.a. on the original cost. On A’s failure to pay the instalment due on 31.12.2012, after negotiations on 01.01.2013 B agreed to leave two machines with A adjusting the value of the other three machines against the amount due the machines being valued at cost less 40% p.a. depreciation on W.D.V basis. B after spending Rs 6,000 on repairs of each of such machines sold @ Rs 70,000 each on 30th June 2013. Prepare the relevant accounts in the books of A and B.

Click here for Solution: 8a in PDF

Click here for Solution: 8b in PDF

Click here for Solution: 8c in PDF