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 :
•
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
instalments.
•
every instalment will be treated to be the
hire charges of the goods which is being used by the purchaser.
•
if all instalments are paid as per the
terms of agreement , the title of the goods istransferred by vendor to the
purchaser.
•
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:
•
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.
•
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.
•
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.
•
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.
•
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.
•
(i) Hire – Purchaser A/c.
•
(ii) Hire – Sales A/c. (only in first year)
•
(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
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