Meaning and Concept of Hire-purchase system.

 -  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 instalments. The instalments 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 instalments but the title on the goods is transferred after the payment of all instalments as per the hire-purchase agreement. The special feature of a hire-purchase transaction is that the payment of every instalment is treated as the payment of hire charges by the purchaser to the hire vendor till the payment of the last instalment.. After the payment of the last instalment, the amount of various instalments 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 :

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

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the purchaser has a right to use the goods delivered.

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the price of the goods will be paid in instalments.

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

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if all instalments are paid as per the terms of agreement , the title of the goods istransferred by vendor to the purchaser.

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if there is a default in the payment of any of the instalments, 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 instalments.

1.5 Difference between Hire-purchase system and Instalment payment system

Instalment 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 instalments. In the event of default in payment of any instalment, 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 Instalment payment system:

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In Hire-purchase system, the transfer of ownership takes place after the paymentof all instalments while in case of Instalment payment system, the ownership istransferred immediately at the time of agreement.

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In Hire-purchase system, the hire-purchase agreement is like a contract of hirethough later on it may become a purchase after the payment of last instalmentwhile in Instalment payment system, the agreement is like a contract of creditpurchase.

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In case of default in payment , in Hire-purchase system the vendor has a right toback goods from the possession of the hire-purchaser while in case of Instalmentpayment system, the vendor has no right to take back the goods from thepossession of the purchaser; he can simply sue for the balance due.

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In Hire-purchase system, if the purchaser sells the goods to a third party beforethe payment of last instalment, the third party does not get a better title on thegoods purchased. But in case of Instalment payment system, the third party gets abetter title on the goods purchased.

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In Hire-purchase system the provisions of the Hire-purchase Act apply to thetransaction while in case of Instalment payment system, the provisions of Sale of Goods Act apply to the transaction.

1.6 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 instalments. 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 instalment due

Asset a/c. Dr (Balancing figure)Intt. A/c. Dr. (Amt. of Intt.)To Hire-Vendor A/c. (Amt. of Instalment)

(iv)

On payment of instalment:

Hire-Vendor A/c Dr. (Amt. of Instalment)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.                 (Total  amt.)To Interest A/c (Bal. of Intt. A/c.)To Depreciation A/c. (Bal. of Dep. A/c.)

Under Total Assets Value Method:

Under this method of accounting in the books of hire-purchaser, is done on theassumption that the ownership of the asset is also transferred to the purchaser with thedelivery 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. (Amount of down payment)To Cash/Bank A/c

(iii)

On becoming the instalment due:

Interest A/c. Dr. (Amount of interest)To Hire-Vendor A/c

(iv)

On payment of instalment:

Hire-Vendor a/c Dr. (Amount ofinstalment)To Cash/Bank A/c

 

(v)

On charging the depreciations:

Depreciation A/c. Dr. (Amount ofdepreciation)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 Intt.A/c.)To Depreciation A/c.         (Bal. of Dep.A/c.)

Posting in Ledger Accounts:

After passing journal entries under any of the methodsdiscussed above, the following ledger accounts are opened in the ledger and the postingsare 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 becalculated 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, thisexcess of payment over the cash price is interest. It is very essential to calculate interestbecause the amount paid for interest is charged to revenue and the asset is capitalized atcash price. Thus normally all instalments 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 instalment:

Where the hire-purchase pricei.e. payment made in the form of down payment and all instalments is more than the cashprice, it is regarded that the interest is included in instalments. It is explained in thefollowing example.

1.7 Accounting in the books of Hire-vendor

 

Hire Vendor: There is only one method of recording the entries in the books of hire-vendor. Irrespective of the fact whether the entries in the books of hire-purchaser arepassed under the Asset Accrual Method or under the Total asset value Method.But theaccounting entries in the books of hire-vendor are always passed under the total AssetMethod. 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 PriceTo 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 InterestTo Interest A/c.

(iv)

On receipt of instalment:

Cash/bank A/c. (Amt. of Instalment)To Hire – Purchaser

(v)

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

Hire – Sales A/c Dr. Cash PriceTo 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 interestincluded in various instalments will be separately calculated as already explained.Posting in Ledger Accounts:

 

After passing entries in the journall of hire – vendor the following accounts will beopened in the ledger of hire – vendor and the postings will be made accordingly.

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(i) Hire – Purchaser A/c.

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

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(iii) Interest A/c.Calculate the amount of annual instalment, and show the Journal entries and necessaryledger accounts in the books of Moti Ltd. for three years. The present value of Annuity of Rupees one for three years at 5% is 2.72325