Accounting for Hire Purchase and Instalment System

BINAYAK ACADEMY, Gandhi Nagar 1st Line, Near NCC Office, Berhampur Contact No: 9776486185, 9078876111

ACCOUNTING FOR HIRE PURCHASE AND INSTALLMENT SYSTEM Meaning of hire purchase contract

A contract of hire purchase is a contract where goods are purchased or sold with the stipulations that: 1.

The delivery of goods will be given by the owner of the goods to the hire purchaser

2.

The payment of the price for the goods will be made in installment

3.

Ownership of the goods passes to the hire purchaser only on payment of all the installment

4. In the event of hire purchaser’s failure to pay any installment, the hire vendor will be entitled to seize the goods and adjust the money paid by the hire purchaser against the hire charges for the use of goods. 

In a contract of hire purchase, the hire vendor parts only with the possession of goods but not with its ownership. He retains the ownership with him till he receives all the stipulated installments of hire.

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The hire purchaser, of course, does not get the ownership but gets the right to use the goods as per his choice. He will get the ownership only on payment of all the stipulated installments.

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In case he decides not to buy the goods, he may terminate the contract by refusing to pay any future installments towards the cost.

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The total payment to be made by a buyer in the case of purchase of goods under the system of hire purchase is always more than the payment that he will have to make in case he buys goods for cash. This is because the hire purchase price, besides cash price of goods, includes the charges for the following: 1.

Interest for payment being made over a period of time instead of a single cash down payment

2.

The risk taken by seller in the event of the buyer’s failure to pay the price of goods

3.

The registration, insurance, expenses, etc. of delivering the goods

The difference between between hire purchase purchase price and the cash price is known by different different names such as hire purchase charges, finance charges and interest charges. Terminology 

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Hire purchase agreementagreement- It means an agreement under which which goods are let on hire and under which which the hirer has an option to purchase them in accordance with the terms of the agreement and includes the agreement under which: 1. Possession of goods is delivered by the owner thereof to a person on condition that such person pays the agreed amount in periodical installments 2.

The property in goods is to pass to such a person on the payment of the last installment; and

3.

Such a person has a right to terminate the agreement at any time before the property so passes

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Hire purchase price -Total sum payable by the t he hirer under a hire purchase agreement

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Hirer – A person who obtains or has obtained possession of the goods from the owner under a hire purchase agreement

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Cash price – Price at which goods goods may be purchased purchased by hirer for cash

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Hire purchase charges – Difference between hire purchase price and cash price as stated in hire purchase agreement

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Net cash price - cash price of goods sold less any deposit payable by hirer by way of initial payment

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Net hire purchase purchase price - Total amount of hire purchase price price less delivery, registration and insurance expenses.

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Net hire purchase charges – Difference between net hire purchase price and net cash price of such goods

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Cash price installments – Amount which bears to the net cash price, the same proportion, as the amount of hire purchase installment bears to the total amount of hire purchase price. It can be expressed as : = Hire purchase installment x Net cash price price

Hire purchase price Systems of accounting records 1


1.

When goods of substantial sales value are the subject matter of sale. e.g. trucks, heavy machinery etc.

2.

When goods of small sales value are the subject matter of sale. e.g. radios, television sets, refrigerators, etc. Accounting records for goods of substantial sales value  In case of hire purchase transactions relating to goods of substantial value, a proper distinction has to be made between cash price and hire purchase charges. Cash price paid by the hire purchaser is an expenditure of a capital nature and hence debited to the concerned asset account and amount paid as interest is revenue expenditure and is ultimately charged to profit and loss account. Calculation of interest a) When cash price, rate of interest, hire purchase price, number of installments etc. are all given – The interest is to be calculated on the outstanding balance of cash price at the stipulated date. b) If rate of interest is not given- The interest included in each installment will be calculated on the basis of the hire purchase price outstanding in the beginning of each year c) If cash price is not given- Interest as well as cash price will be calculated by working backwards Accounting entries in the books of Hire purchaser There are two methods for making accounting entries of the hire purchasing transactions in the books of the hire purchaser: 1.

When asset is recorded at full cash price

2. When asset is recorded at the cash price actually paid When asset is recorded at full cash price In this method, entries regarding hire purchase transactions are recorded on this basis that the hire purchaser having agreed to buy the asset has become practically (not technically) the full owner of the asset. The following journal entries are passed in the books of the buyer for recording hire purchase transactions according to this method: 1. On purchase of asset: Asset A/c

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To Hire vendor (With full cash price of the asset) 2. On making cash down payment: Hire vendor A/c Dr. To Cash/bank (with actual cash down payment) 3. For interest due: Interest A/c

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To Hire vendor (Interest is calculated on outstanding amount when installment become due) 4. On payment of hire purchase installment Hire vendor A/c Dr. To Cash/bank (with amount paid) 5. For depreciation of the asset: Depreciation A/c Dr. To Asset A/c (At the end of the accounting period) 2


At the end of the accounting period, the total amount of interest due to the hire vendor and depreciation of the asset are transferred to the Profit and Loss A/c. In case any expenditure is incurred on repairs of the asset, the amount will also be charged to the Profit and Loss A/c of the year in which such repairs are done. At the end of the accounting year, the asset account and the vendor’s account will appear in the balance sheet as follows: When asset is recorded at the cash price actually paid This method recognizes the fact that the hire purchaser does not become the owner of the asset till he makes the payment of final installment. Hence, no entry is passed when agreement for hire purchase is signed. Entries are passed at the time of payment of each installment. The following journal entries are passed for hire purchase transactions according to this method: 1. On making cash down payment: Asset A/c

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To Cash/bank (With actual cash down payment) 2. On hire purchase installment becoming due Asset A/c

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Interest A/c

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To Hire vendor (Asset account id debited with the amount of cash price included in each installment. The interest on outstanding cash price is debited tot the interest account) 3. On payment of hire purchase installment Hire vendor A/c

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To Cash/bank (with amount paid) 4. For depreciation of the asset: Depreciation A/c Dr. To Asset A/c (At the end of the accounting period) At the end of the accounting period, the total amount of interest due to the hire vendor and depreciation of the asset are transferred to the Profit and Loss A/c as in the earlier case. Since hire vendor’s account is credited only with the amount of installment due and not with full cash price and, therefore, there will be no balance in his account once his installment is paid to him. The asset account will appear in the balance sheet as follows: Accounting entries in the books of Hire vendor The hire vendor takes the sale of goods on hire purchase as an ordinary sale. He, therefore, debits the account of the hire purchaser and credits the sales account with the full cash price as soon as the contract is signed. The journal entries to be passed by the hire vendor are as follows: 1. On sale of goods under hire purchase: Hire purchaser A/c

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To Sales A/c (With full cash price) 2.

On receiving cash down payment: Cash/bank A/c

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To Hire purchaser (With the amount of cash down payment) 3. For interest due Hire purchaser A/c

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To Interest A/c (Interest is calculated when any installment becomes due on t he outstanding balance in the account of the hire purchaser) 4. On getting payment of the installment Cash/bank A/c

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To Hire purchaser (With the amount of installment received) Default and repossession 

In case the hire purchaser fails to make payment of an installment, the hire vendor may seize the goods and forfeit all amounts paid by the hire purchaser so far.

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Seizure of goods may be partial or full depending on the circumstances and the agreement between the parties. Of course, in case of partial seizure, only a part of the amount paid by the hire purchaser will be forfeited by the hire vendor. The hire vendor may, after seizing the goods, spend some money on the goods for getting them repaired and reconditioned and later on sell them.

Journal entries for Default and repossession (In the books of buyer) 1. Usual entries for interest and depreciation till due date of the installment should be passed. 2. In case of full seizure of the asset by the hire vendor, any amount standing to the credit of the hire vendor will be transferred to the asset account. Any balance in the asset account will be transferred to the Profit and Loss account. a) For transferring the balance of the vendor’s account Hire vendor A/c

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To asset A/c b) For transferring the balance of the asset account Profit and Loss A/c Dr. To Asset A/c 1. Usual entries for interest and depreciation till due date of the installment should be passed. 2. In case of full seizure of the asset by the hire vendor, any amount standing to the credit of the hire vendor will be transferred to the asset account. Any balance in the asset account will be transferred to the Profit and Loss account. a) For transferring the balance of the vendor’s accou nt Hire vendor A/c

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To asset A/c b) For transferring the balance of the asset account Profit and Loss A/c Dr. To Asset A/c Partial seizure  Sometimes hire vendor may leave a portion of the asset with the hire purchaser. In such a case, an agreement is made regarding the value at which the seized asset will be taken back by the hire vendor. The value so agreed will be debited to the hire vendor and credited to the asset account. Such value is generally lower than the value at which the asset is appearing in the books of the hire purchaser. The difference between the book value of the asset and the value at which it has been taken over by the hire vendor is a loss which will be written off from the Profit and Loss account. Entries in the books of hire vendor 1. The hire vendor will pass usual entry for the interest due from the hire purchaser till the due date of the installment 4


2. On repossession of goods: Goods repossessed A/c

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To Hire purchaser (With the amount due from the hire purchaser or, in case of partial seizure, with the value agreed) 3. For repairs, etc. of the goods repossessed: Goods repossessed A/c

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To Bank 4. On selling of the goods repossessed: Cash/bank A/c

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To Goods repossessed A/c 5. Any profit or loss on sale of repossessed goods will be transferred to the Profit and loss account For loss: Profit and loss A/c Dr. To Goods repossessed A/c For profit: The entry will be reversed Accounting records for goods of small sales value

In cases where the goods sold on hire purchase are of small sales value, the transactions are numerous, and the parties of agreement vary, it is necessary to have a simple but adequate system of maintaining record of hire purchase transactions. It may not be possible for the vendor to keep an account of each individual customer to whom he has sold the goods on hire purchase. He generally maintains a memorandum record of the hire purchase transactions in a hire purchase sales register with appropriate columns. Information collected from the hire purchase sales register 

1.

Cost price of the goods sold on hire purchase- It is the cost of goods sent on hire purchase. Cost will be recorded only to the extent of installment due

2.

Value of goods sold on hire purchase- It is the value of goods sent on hire purchase and actual sales will be recorded to the extent of hire purchase installments due.

3.

Cash received- Total of the cash down payment and amount of installment paid by the hire purchase customer during the accounting year

4.

Total installments due but unpaid- Amount of installments which have become due during the accounting year but has not been paid by the customers. This amou nt is also called ‘Hire purchase debtors’

5.

Total amount of “installments not yet due”- Total amount of those installments in respect of goods sold on hire purchase which are to be received in the next accounting period. It is also called ‘hire purchase stock’ or ‘stock with the customers’ Ascertainment of profit 

The profit made by the vendor on hire purchase transactions in case of goods of small sales value can be ascertained by any of the following two methods: 1.

Debtor’s method

2.

Stock and debtor’s method

Debtor’s method 

In case of this method, a hire purchase trading account is prepared to ascertain the amount of profit or loss made on goods sold on hire purchase. The accounting entries are shown below:

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For goods sold on hire purchase: Hire purchase trading A/c

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To Goods sold on Hire purchase A/c (At hire purchase price) 5

BINAYAK ACADEMY, Gandhi Nagar 1st Line, Near NCC Office, Berhampur Contact No: 9776486185, 9078876111 

For cash received from customers: Cash A/c

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To Hire purchase trading A/c 

For installments due but unpaid at the end of the accounting year: Hire purchase Debtors stock A/c

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For installments not yet due at the end of the accounting year: Hire purchase stock A/c

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For ascertaining profit- Since the goods sold on hire purchase as well as stock lying with hire purchase customers are being shown at hire purchase price, it will be necessary to make proper adjustments for loading in the hire purchase trading account by means of the following entries: a) For loading included in goods sold on hire purchase Goods sold on Hire purchase A/c Dr. To Hire purchase trading A/c b) For loading included in ‘stock with the customers’ a t the end of the accounting year Hire purchase trading A/c

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To stock reserve 

For installments not yet due at the end of the accounting year: Hire purchase stock A/c

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For ascertaining profit- Since the goods sold on hire purchase as well as stock lying with hire purchase customers are being shown at hire purchase price, it will be necessary to make proper adjustments for loading in the hire purchase trading account by means of the following entries: a) For loading included in goods sold on hire purchase Goods sold on Hire purchase A/c Dr. To Hire purchase trading A/c b) For loading included in ‘stock with the customers’ at the end of the accounting ye ar Hire purchase trading A/c

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To stock reserve 

Hire purchase stock at the end of the accounting year becomes the opening stock of the next accounting year. It will, therefore, be shown on the debit side of the hire purchase trading account next year. The balance in the stock reserve account, carried forward from the last year, will be transferred to the hire purchase trading account by means of the following entry: Stock reserve A/c

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For transfer of cost of goods sold on hire purchase- The balance of the goods sold on hire purchase account represents the cost of goods sold on hire purchase. It will be transferred to the ordinary trading account or the purchases account by means of the following journal entry: Goods sold on hire purchase A/c Dr. To Trading/purchase A/c

Default and repossession 

In the event of hire purchaser’s failure to pay the installment on the due date, the hire vendor may seize the goods and forfeit installments so far paid by him. The following journal entry will be passed in the event of such a seizure in the books of the hire vendor: 6


Goods repossessed A/c

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The true value of the goods repossessed may be ascertained on the basis of following formula:

Unpaid amount x Cost price of the goods sold on hire purchase/ hire purchase price Memorandum hire purchase trading Account If the hire purchase trading account is prepared at the hire purchase price (without making adjustments for loading), the two sides of the hire purchase trading account will tally. Thus, any missing information can be found out by preparing a Memorandum hire purchase trading Account. After finding out the information, the hire purchase trading account may be prepared and the profit can be ascertained after making adjustments for loading Calculation of profit or loss on Hire purchase  Having prepared the memorandum hire purchase trading account, profit or loss made on hire purchase can be ascertained either by preparing a Hire Purchase Adjustment A/c or by a Hire Purchase Trading A/c. Stock and Debtors system 

The profit made on hire purchase transactions can also be ascertained according to Stock an d debtor’s system is done as in the case of branch accounts. Separate accounts are opened for Hire purchase stock A/c, Hire purchase Debtor’s A/c, Goods sold on hire purchase A/c, Hire purchase adjustment A/c etc. Journal entries under stock and Debtor’s s ystem 

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For goods sold on hire purchase

Hire purchase stock A/c

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To Goods sold on hire purchase (at hire purchase price) 

For receiving cash down payments

Cash/bank A/c

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To Hire purchase stock A/c 

For total installments due during the year

Hire purchase Debtors A/c

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To Hire purchase stock A/c 

For installments received from hire purchase customer

Cash/bank A/c

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To Hire purchase Debtors A/c 

For goods repossessed

Goods repossessed A/c

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(with the amount unpaid)

To hire purchase stock A/c

(with the amount not due)

To Hire purchase debtors A/c

(with the amount due)

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For loss on goods repossessed

Hire purchase adjustment A/c

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To Goods repossessed A/c (with the difference between installments unpaid and realisable value of the goods repossessed) 

For loading in closing stock with customers


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To Stock reserve 

For loading in opening stock with customers

Stock reserve A/c

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To Hire purchase adjustment A/c (opening stock of this year must have been the closing stock of the last year and hence stock reserve must have been created last year. This account is now closed by transferring it to Hire purchase adjustment A/c) 

For loading in goods sold on hire purchase

Goods sold on hire purchase A/c

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To Hire purchase adjustment A/c 

For transfer of profit on hire purchase


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To profit and loss A/c 

For transfer of balance of ‘Goods sold on hire purchase A/c’ representing goods sold on hire purchase

Goods sold on hire purchase A/c

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To Purchases (or general trading or Stock at shop) A/c Concept of Installment System

An installment system is just like a credit purchase and hire purchase system of selling and buying goods. Like hire purchase, in installment system an agreement is made between buyer and seller to purchase and sell of goods. The buyer makes certain down payment at the time of signing agreement and the balance is paying in installment over a period of time. An installment system is a credit sale in which payments are made in installments over a period of time. In this system, the buyer gets the possession as well as ownership of the goods right at the time of signing the agreement. During the course of paying the installment, if the buyer makes default in paying the installment, the vendor cannot responses the goods. In that case, the vendor can sue the buyer for recovery of dues. Like in hire purchase even the paid installments also cannot be forfeited in case of default in paying installment. Thus, it can be said that installment system is a kind of credit sale where installments are entertained over the period and default in such payment cannot responses the goods and in that case, the vendor can only sue the buyer for the recovery of amount due. Features of Installment Purchase System

The following are the 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. Risk of goods/assets is 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. DIFFERENCE BETWEEN HIRE PURCHASE AND INSTALMENT SYSTEM 1. Nature Of Contract Hire Purchase System: It is a hiring goods agreement. Instalment System: It is an agreement of sale. 2. Ownership

Hire Purchase System: Ownership of goods is transferred after the payment of final instalment. Instalment System: Ownership of the goods passes to the buyer just signing the agreement. 8


3. Right

Hire Purchase System: The buyer cannot sell, destroy or transfer the goods. Instalment System: The buyer can sell, destroy or mortgage or transfer as his/her wish. 4. Risk

Hire Purchase System: All the risks are borne by the vendor before the payment of final instalment. Instalment System: All the risks are to be borne by the buyer from the date of agreement. 5. Right of Return

Hire Purchase System: The buyer can return the goods before making the final instalment. Instalment System: The buyer cannot return the goods to the seller. 6. Repair and Maintenance

Hire Purchase System: The liability of repair and maintenance lies with the seller provided that the buyer takes the utmost good care. Instalment System: The buyer is responsible for repair and maintenance. 7. Forfeiture of Instalment Paid

Hire Purchase System: In case of default in payment of instalment, paid instalment will be forfeited and treated as hire charges. Installment System: The act of forfeiture cannot be activated.

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Accounting for Hire Purchase and Instalment System

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