Introduction:

Now-a-days the books of accounts are maintained under double entry system by all big
business houses and multinationals. You know that the sales are the Key factor of success
of business. The profit of a business always depends on the volume of its sales. A big
business house can affect sales on cash basis as well as on credit basis. The credit sales
are very important and essential for the growth of business. The sale proceeds under such
sales are not immediately collected but are collected under certain arrangements such as
Hire-purchase system or Installment payment system or collection after a certain period
together with interest on outstanding balances. Hire-purchase system is the most secured
and effective tool of collecting the proceeds of a credit sale.
Hire purchase (abbreviated HP) is the legal term for a contract, in this persons usually
agree to pay for goods in parts or a percentage at a time. It was developed in the United
Kingdom and can now be found in China, Japan, Malaysia, India, Australia, and New
Zealand. It is also called closed-end leasing. In cases where a buyer cannot afford to pay
the asked price for an item of property as a lump sum but can afford to pay a percentage
as a deposit, a hire-purchase contract allows the buyer to hire the goods for a monthly
rent. When a sum equal to the original full price plus interest has been paid in equal
installments, the buyer may then exercise an option to buy the goods at a predetermined
price (usually a nominal sum) or return the goods to the owner. In Canada and the United
States, a hire purchase is termed an installment plan; other analogous practices are
described as closed-end leasing or rent to own.
Hire purchase differs from a mortgage and similar forms of lien-secured credit in that the
so-called buyer who has the use of the goods is not the legal owner during the term of the
hire-purchase contract. If the buyer defaults in paying the installments, the owner may
repossess the goods, a vendor protection not available with unsecured-consumer-credit
systems. HP is frequently advantageous to consumers because it spreads the cost of
expensive items over an extended time period. Business consumers may find the different
balance sheet and taxation treatment of hire-purchased goods beneficial to their taxable

income. The need for HP is reduced when consumers have collateral or other forms of
credit readily available.

Meaning and Concept of Hire-purchase system:

Hire-purchase system is a special system of purchase and sale of goods. Under this
system purchaser pays the price of the goods in installments. The installments may be
annual, six monthly, quarterly, monthly fortnightly etc. Under this system the goods are
delivered to the purchaser at the time of agreement before the payment of installments but
the title on the goods is transferred after the payment of all installments as per the hirepurchase agreement. The special feature of a hire-purchase transaction is that the payment
of every installment is treated as the payment of hire charges by the purchaser to the hire
vendor till the payment of the last installment. After the payment of the last installment,
the amount of various installments paid is appropriated towards the payment of the price
of the goods sold and the ownership or the goods is transferred to the purchaser. Thus
hire-purchase means a transaction where the goods are sold by vendor to the purchaser
under the following conditions:

The goods will be delivered to the purchaser at the time of agreement.

The purchaser has a right to use the goods delivered.

The price of the goods will be paid in installments.

Every installment will be treated to be the hire charges of the goods which is
being used by the purchaser.

If all installments are paid as per the terms of agreement, the title of the goods is
transferred by vendor to the purchaser.

If there is a default in the payment of any of the installments, the vendor will take
away the goods from the possession of the purchaser without refunding him any
amount received earlier in the form of various installments.

The contents of a hire-purchase agreement:

Hire-purchase agreement means a contract between the hire vendor and the hire
purchaser regarding the sale of goods under certain conditions. Usually every hirepurchase agreement shall contain the following terms:

A clear description of the goods.

The cash price of the goods, cash price means the price at which goods may be
purchased against cash payment.

The hire-purchase price, hire purchase price means the total amount which is
payable by the hire-purchase under the agreement.

The date on which the hire-purchase agreement will commence.

The description of the goods that will be delivered to the hire-purchase at the
commencement of the agreement.

The number of installments to be paid by the hire-purchase along with the amount
of each installment and the date of payment of each installment.

The down payment if any, the down payment means the amount which is required
to be paid by hire-purchase to the hire vendor at the time of commencement of
hire-purchase agreement.

The rate interest charged by the hire vendor (optional).

A reasonably comprehensive statement of the parties' rights (sometimes including

the right to cancel the agreement during a "cooling-off" period).

The right of the hirer to terminate the contract when he feels like doing so with a
valid reason.

The seller and the owner

If 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, including Ireland, 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 hirer
The extent to which buyers are protected varies from jurisdiction to jurisdiction, but the
following are usually present:

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 contract
The owner will be able to pass title to, or ownership of, the goods when the

contract requires it
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

liability
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 rights

The hirer usually has the following rights:

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)

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 value
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 rating

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.

Basically hirer have following rights1. Rights of protection

2. Rights of notice
3. Rights of repossession
4. Rights of Statement
5. Rights of excess amount
The hirer's obligations
The hirer usually has the following obligations:

To pay the hire installments

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, compensate the owner for any loss in asset value)

To inform the owner where the goods will be kept.

A hirer can sell the products if an only if he has purchased the goods finally or
else not to any other third party.

The owner's rights

The 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:

to forfeit the deposit

to retain the installments already paid and recover the balance due
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)
to claim damages for any loss suffered

Characteristics of Hire-Purchase System:

The characteristics of hire-purchase system are as under:

Hire-purchase is a credit purchase.

The price under hire-purchase system is paid in installments.

The goods are delivered in the possession of the purchaser at the time of
commencement of the agreement.

Hire vendor continues to be the owner of the goods till the payment of last
installment.

The hire-purchase has a right to use the goods as a bailer.

The hire-purchase has a right to terminate the agreement at any time in the
capacity of a hirer.

The hire-purchase becomes the owner of the goods after the payment of all
installments as per the agreement.

If there is a default in the payment of any installment, the hire vendor will take
away the goods from the possession of the purchaser without refunding him any
amount.

Difference between Hire-purchase system and Installment payment system

Installment Payment System is system of purchase and sale of goods in which title of
goods is immediately transferred to the purchaser at the time of sale of goods and the sale
price of the goods is paid in installments. In the event of default in payment of any
installment, the seller has no right to take back goods from the possession of the
purchaser. He can file a suit for the recovery of the outstanding balance of the price of
goods sold. The followings are the differences between Hire-purchase system and
Installment payment system:

In Hire-purchase system, the transfer of ownership takes place after the payment
of all installments while in case of Installment payment system, the ownership is
transferred immediately at the time of agreement.

In Hire-purchase system, the hire-purchase agreement is like a contract of hire

though later on it may become a purchase after the payment of last installment

while in Installment payment system, the agreement is like a contract of credit

purchase.

In case of default in payment, in Hire-purchase system the vendor has a right to

back goods from the possession of the hire-purchase while in case of Installment
payment system, the vendor has no right to take back the goods from the
possession of the purchaser; he can simply sue for the balance due.

In Hire-purchase system, if the purchaser sells the goods to a third party before
the payment of last installment, the third party does not get a better title on the
goods purchased. But in case of Installment payment system, the third party gets a
better title on the goods purchased.

In Hire-purchase system the provisions of the Hire-purchase Act apply to the

transaction while in case of Installment payment system, the provisions of Sale of
Goods Act apply to the transaction.

Accounting In the books of Hire-purchaser:

There are two methods of accounting in the books of Hire-purchaser. Their detailed
description is as under:

Asset Accrual Method:

Under this method it is considered that the hire-purchaser is the owner of the asset up to
the value of the cash price paid by him in the form of down payment or the cash price
paid included in various installments. The following journal entries are recorded under
this method.

(i)On taking the delivery of asset:

No entry is recorded.

(ii)On making the down payment (if any)

Asset A/c Dr.

(Amount of down payment)

To Cash/Bank A/c.

(iii)On becoming the installment due

Asset a/c. Dr
Installment. A/c. Dr.
To Hire-Vendor A/c.

(Balancing figure)
(Amt. of Installment)
(Amt. of Installment)

(iv)On payment of installment:

Hire-Vendor A/c Dr.

(Amt. of Installment)

To Cash/Bank A/c.

(v)On charging the Depreciation:

Depreciation A/c Dr.

(Amt. of Depreciation)

To Asset A/c.
(vi)On Transfer of interest and depreciation to P/L A/c:
P/L A/c.

Dr.

(Total amount.)

To Interest A/c

(Bal. of interest. A/c.)

To Depreciation A/c.

(Bal. of Depreciation. A/c.)

Under Total Assets Value Method:

Under this method of accounting in the books of hire-purchaser, is done on the
assumption that the ownership of the asset is also transferred to the purchaser with the
delivery of goods. The following journal entries are recorded under this method.

(i)On taking the delivery of assets at the time of agreement:

Asset A/c Dr.

(Cash price of Asset)

To Hire vendor A/c.

(ii)On making the down-payment (if any):

Hire-Vendor....... A/c. Dr.
To Cash/Bank A/c

(Amount of down payment)

(iii)On becoming the installment due:

Interest A/c. Dr.

(Amount of interest)

To Hire-Vendor A/c

(iv)On payment of installment:

Hire-Vendor a/c Dr.

(Amount of installment)

To Cash/Bank A/c

(v)On charging the depreciations:

Depreciation A/c. Dr.

(Amount of depreciation)

To Asset A/c.

(vi)On Transfer of interest and depreciation to P/L A/c:

P/L A/c. Dr.

(Total)

To Interest A/c.

(Bal. of Interest. A/c.)

To Depreciation A/c.

(Bal. of Dep. A/c.)

Posting in Ledger Accounts:

After passing journal entries under any of the methods discussed above then the
following ledger accounts are opened in the ledger and the postings are made
accordingly.
(i) Asset A/c. (e.g. Trucks A/c, Machinery A/c. etc.)
(ii) Vendor's A/c.
(iii) Interest A/c.
(iv) Depreciation A/c.
Note: Before recording the entries the amounts of interest and depreciation will be
calculated in two separate tables showing the calculations of interest and depreciation.
Calculation of Interest
The total payment made under hire-purchase system is more than cash price. In fact, this
excess of payment over the cash price is interest. It is very essential to calculate interest
because the amount paid for interest is charged to revenue and the asset is capitalized at
cash price. Thus normally all installments will include a part of cash price and a part of
interest on the outstanding balance. However the amount paid at the time of agreement
(down payment) will not include any interest. The calculation of interest is made under
two conditions:

(a) When interest is included in amount of installment:

Where the hire-purchase price i.e. payment made in the form of down payment
and all installments is more than the cash price, it is regarded that the interest is
included in installments. It is explained in the following example.

Worked out Example-1 (Calculation of Interest)

On Its April,2005 Mr. X purchased from M/s Y & Co. one 'Motor Truck' under hirepurchase system, Rs. 5,000 being paid on delivery and the balance in five annual
installments of Rs. 7,500 each payable on 31st March each year. The cash price of the
motor truck is Rs. 37,500 and vendors charge interest at the rate of 5 per cent per annum
on yearly balances. Find out the amounts of principal and interest included in each
installment.

Calculation of interest
Calculation of interest

Cash price
Rs

Principal
Rs

Installment
Interest

Total Rs

Cash price
Less paid on delivery
First installment
Less interest on
Rs.3200@5%
Principal
Second installment
Less interest on
Rs.3200@5%
Principal

37500
(5000)
32500

5000

-------

5000

(5,875)
26,625

5875

1625

7500

(6,169)
20,456

6,169

1,331

7500

(6,477)
13,979

6,477

1,023

7500

(6,801)
7,178

6,801

699

7,500

(7178)
Nil

7,178
37,500

322
5,000

7,500
42,500

7,500
1,625
5,875
7,500
1,331
6,169

Third installment
7,500
Less interest on
Rs.3200@5%
Principal
Fourth installment
Less interest on
Rs.3200@5%
Principal

1,023
6,477
7,500
699
6,801

Fifth installment
7,500
Less Amount unpaid 7,178
Interest
322
Total:

(b) When interest is not included in installments:

Where the total amount paid in the form of down payment and all installments is
exactly equal to the cash price, it is regarded that the interest is not included in
installments. It means that interest is payable in addition to the agreed amount of
installment. It is explained in the following example.

Worked out Example-2 (Calculation of Interest):

On April 1,2005, A Transport Company purchased a Motor Lorry from Motor Supply Co.
Ltd. on hire-purchase basis, the cash price being Rs. 60,000. Rs. 15,000 on signing of the
contract and balance in three annual installments of Rs. 15,000 each on 31st March every
year. In addition to it, interest at 5 per cent per annum was also payable to vendors on
outstanding balances.

Description

Cash
price
60,000

Cash Price
Less :down payment

(15,000)

Principal

installments
interest
total

15,000

15,000

15,000

2,250

17,250

15,000

1,250

16,500

15,000

750

15,750

45,000
1st

installment

15,000
Int.@5%

on

45,000

2,250

15,000
30,000

Total:
17,250

15,000
2nd

installment

15,000

15,000
Int.@5%

on

30,000

1,500
Total:
16,500

15,000

Nil
60,000
3rd

4,500

64,500

installment

15,000
Int.@5%

on

15,000

750
Total:
15,750

Tot
al:

Accounting in the books of Hire-vendor

Hire Vendor: There is only one method of recording the entries in the books of hirevendor. Irrespective of the fact whether the entries in the books of hire-purchaser are
passed under the Asset Accrual Method or under the Total asset value Method. But the
accounting entries in the books of hire-vendor are always passed under the total Asset
Method. These entries are as under:(i)On delivery of goods to the hire-purchaser at the time of agreement:
Hire purchaser A/c Dr.

Cash Price

To Hire Sales A/c.

(ii)On receipt of cash at the time of agreement (down payment), if any:

Cash/Bank A/c. Dr.

(Amt. of down payment)

To Hire-Purchaser

(iii)On interest being due:

Hire Purchaser A/c Dr.

Amt. of Interest

To Interest A/c.

(iv)On receipt of installment:

Cash/bank A/c.

(Amt. of Installment)

To Hire Purchaser

(v)On Transfer of Balance of Hire-Sales A/c. to Trading A/c. (at the end of first year
only):
Hire Sales A/c Dr.

Cash Price

To Trading A/c.

(vi)On Transfer of amount of interest to P/L A/c:

Interest A/c. Dr.

(Balance of Intt. A/c.)

To P/L A/c.

Note: In solving a numerical problem, before recording the entries, the amount of interest
included in various instalments will be separately calculated as already explained.
Posting in Ledger Accounts:

After passing entries in the journal of hire vendor the following accounts will be
opened in the ledger of hire vendor and the postings will be made accordingly.

(i) Hire Purchaser A/c.

(ii) Hire Sales A/c. (only in first year)

(iii) Interest A/c.