HIRE PURCHASE AND INSTALLAMENT SYSTEM

Hire Purchase system

It is a system of purchase under which the buyers enters into agreement with the seller to pay
the price in installments. The buyer gets the possession of goods immediately on paying the down
payment but does not get ownership. He becomes the owner only after the last installment is paid.
Under this system the buyer fails to pay any installment, the seller has the right to tack back the
goods.
Difference between hire purchase and sale
The main difference between hire purchase agreement and sale are given below:
1. Under the sales ownership is transferred at the time of purchase. But under hire purchase
ownership is transferred only after payment of the last installment
2. In the case of sale payment of price is generally made in lump sum. In the case of hire
purchase payment of price is always made installment
3. In the case of sales buyer can dispose of the goods in any way he likes. But a buyer under hire
purchase agreement has no such right before he becomes the owner on payment of the
installment.
4. In the case of sale on credit the seller can sue the buyer for the payment of the price
outstanding. Bur a seller under hire purchase system can take back the goods in case of default
by the buyer in payment of any installment
5. In case of sale, the buyer’s position is like that of an owner. But the position of an under hire
purchase is like that of a bailee in respect of the goods until he becomes the owner.
6. In case of sale on immediate cash, the price does not include any interest. But under hire
purchase the installment includes interest.
Accounting for hire purchase transactions
In the books of hire purchaser
There are two methods for making entries of the hire purchase transactions in the books of hire
purchaser.
1) When asset is recorded at full cash price and
2) When asset is recorded at the cash price actually paid
When asset is recorded at full cash price
Under this method the asset is recorded at the full price. Thus this method treats the hire
purchaser as owner of the asset.
Accounting entries in the books hire purchaser as follows:
1) When the asset is acquired on hire purchase
Asset account Dr.
To hire vendor a/c (cash price)
 2) When down payment is made
Hire vendor a/c Dr.
To cash a/c
3) When interest becomes due
Interest a/c Dr.
To hire vendor a/c
4) When installment is paid
Hire vendor a/c Dr.
To cash
5) When depreciation is charged on asset
Depreciation a/c Dr.
To asset
6) For closing interest
P & L a/c Dr.
To interest
7) For closing depreciation
P & L a/c Dr.
To Depreciation a/c
In the books of hire vendor
Accounting entries are as follows:
1) When the asset is sold
Hire purchase a/c Dr.
To hire purchase sales a/c
2) When down payment received
Cash a/c Dr.
To hire purchase a/c
3) When interest become due
Hire purchase a/c Dr.
To interest
4) When installment received
Cash A/c Dr.
To hire purchaser
5) For closing interest
Interest a/c Dr.
To P & L a/c
Illustration 1

On 1st Jan. 2008 A Ltd purchased from B Ltd .five trucks under hire purchase
system. 50,000 frs being paid on delivery and the balance in five installments of
75,000frs each payable annually on 31st Dec. the vendor charges 5% p.a interest on
yearly balances. The cash price of five trucks was 375,000 frs.
Required: Show how this transaction should be recorded in
a) The books of A ltd, if A Ltd writes off depreciation at 10% p.a on the written
down value.
b) The books of B ltd
Solution
In the books of A Ltd
Trucks account
2008 B Ltd 375,000 2008 Depreciation 37,500
Jan 1 Dec 31 Balance c /d 337,500
375,000 375,000
Balance b/d 337 500 33,750
Depreciation 303,750

2009 337,500 Dec 31 Balance c/d

337,500
Jan 1 Balance b /d

337,500 30380
2010 Depreciation
273,370
Jan 1 Dec 31 Balance c/d
303,750 303750
Balance b /d

2011 303750 Depreciation 27340

Jan 1 Dec 31 Balance c/d 246030
Balance b /d 273370 273370
24600
273370 Dec 31 Depreciation 241430
246030 Balance c/d
2012 Balance b/d
Jan 1 246030 246030
 B Ltd
2008 Jan 1 Trucks 375000
Jan 1
Cash 50000
Dec 31
Cash 75000 Dec 31 Interest 16250
Balance b/d 266250

391250
391250 266250
2009
Dec 31
Cash 75000 Jan Balance b/d By 13310
Balance c/d 204560 1 Interest
279560
st
31
Dec.

2010 279560 204560

Cash Balance b/d
Dec 31 75000 Jan 1 10230
Balance c/d Interest
139790 31st
Dec

214790 214790
2011 Jan 1
75000 139790
Cash Balance b/d
Dec 31 st
71780 31 6990
Balance c/d Dec Interest

146780 146780

Jan
2012
Cash 75000 1 Balance b/d 71780
Dec 31 st
31 3220
Interest
Dec

75000 75000
 Interest account

2000 Dec31 B Ltd. 16250 31st Dec P&L a/c 16250

2000 Dec 31 B Ltd. 13310 31st Dec P&L a/c 13310

]
10230 10230
2000 Dec 31 B Ltd. 31st Dec P&L a/c

2000 Dec 31 6990 31st Dec P&L a/c 6990

B Ltd.

2000 Dec 31 B Ltd. 3220 31st Dec P&L a/c 3220

CALCULATION OF INTEREST
1. Calculation of interest when cash price and rate of interest and amount of installment are
given – total interest is the difference between hire purchase price and cash price. Interest
for each year is calculated on the amount of outstanding cash price
2. Calculation of interest when cash price and amount of installment are given. In the case ,
total interest apportioned to each year on the ratio of installment price outstanding
3. When rate of interest and installment are given but total cash price is not given. In this
method, interest is calculated from the last year firstly and then previous year and at last
fist year. For this purpose. Rate of interest must be converted on cash to on installment.
Default and re possession
When hire purchaser is not able to make the payment in time, then default is committed by
him and the owner takes back the possession of goods. There are two possibilities:
 1) When seller takes back the possession of complete goods
2) When seller takes possession of only part of the total assets sold

When seller takes back the possession of complete goods

In the case accounting treatment is as follows:

In the books of purchaser:

1) All entries are passed as usual up to the date of default.

2) Buyer closes the account of seller by passing the entry:
Hire vendor account Dr
To assets account
3) Any balance left in asset account is closed by transferring to P & L account.
In the books of seller
1) All entries are passed as usual up to the date of default.
2) Seller closes the purchaser account by passing:
Re possessed goods account Dr.
To hire purchaser
3) Re possessed goods account or goods returned account is debited with all expenses
incurred and re sale price is credited and if any balance, it is transferred to P & L
account.

When seller takes possession of the total assets sold

In the case accounting entries are similar to those of complete repossession. The
additional precautions to be taken are:

1) Both the buyer and seller do not closes seller’s account and buyer’s account in their
respective books. The entry for repossession is passed with the agreed value of assets
taken by the vendor.
2) The buyer finds out the value of asset still left with him using the normal rate of
depreciation. This account shows the balance of asset, which is left, to him
3) After crediting the asset account with the value of asset taken away by the seller
and after keeping the balance of asset left, the difference by the asset
account is transferred to P&L account

Illustration 3
A Machinery is sold on hire purchase. The terms of payment is four annual installment of 6000 frs
at the end of each year commencing from the date of agreement. Interest is charged @ 20% and is
included in the annual payment of 6000 frs.

Required:
 Show machinery account and hire vendors account in the books of the purchaser who
defaulted in the payment of the third yearly payment where upon the vendors re-possessed the
machinery. The purchaser provides depreciation on the machinery @ 10% p. a on written down value
method. All workings should form part of your answer
Solution
CALCULATION OF CASH PRICE

No. of Amount due after Amount of Total Interest Opening

install- payment of installment installment amount 20/120 Balance
ment

‐‐‐‐‐ 6000 6000 1000 5000

1
5000 6000 11000 1833 9167
2
9167 6000 15167 2528 12639
3
12639 6000 18639 3106 15533
4

Cash price of the machinery is 15533 frs

MACHINERY ACCOUNT

YEAR frs YEAR frs

I Hire vendors 15533 I Depreciation a/c 1553
Balance c/d 13980
15533 15533

II Balance b/d 13980 II Depreciation a/c 1398

Balance c/d 12582
13980 13980

III Balance b/d III Depreciation a/c

12582 1258
Hire vendor a/c
11000
Profit & loss a/c (
324
loss in default
12582 12582
 HIRE VENDOR A/C

YEAR frs. YEAR frs.

I Bank a/c To 6000 I Machinery a/c 15533

Balance c/d 12639 Interest a/c 3106

18639 18639

II Bank a/c To 6000 II Balance b/d 12639

Balance c/d 9167 Interest a/c 2528

15167 15167

11000 9167
III Machinery a/c III Balance b/d
1833
( transfer) Interest a/c
11000 11000

Illustration 4

P purchased a truck on hire purchase system for 56000 frs payment to be made,15000 frs down
and 3 installments 15000 frs. each at the end of each year. Rate of interest is charged at
5% per annum. The buyer is depreciating the asset at 10% p.a on written down value
method.

Because of financial difficulties, P after having paid down payment and first installment at the
end of the first year could not pay second installment and sellers took possession of the truck
sellers after expanding 357 frs on repairs of the asset sold it away for 30110 frs.

Required: Open ledger accounts in the books of both parties to record transactions.
Solution

IN THE BOOKS OF
P TRUCK ACCOUNT
Year1 frs Year I frs
Jan1 Hire vendor 56000 Dec 31 Depreciation @10% 5600
Balance c/d
50400

56000 56000
II Depreciation
Jan 1 Balance b/d 50400 II ‘’ hire vendor 5040
Dec 31 ‘’ P & L A/c 29453
(balancing figure) 15907

50400 50400

HIRE VENDOR
Year frs Year I frs
I JAN Bank a/c 15000 Jan 1 Truck a/c 56000
1 bank a/c 15000 Interest 2050
Dec 31 ‘’ balance c/d 28050
58050 58050

II II
Dec 31 To truck a/c 29453 Jan 1 Balance b/d By 28050
Dec 31 Interest a/c 1403
29453 29453
 IN THE BOOKS OF HIRE
VENDOR P’s ACCOUNT
Year I frs Year I frs.
Jan 1 Hire sales a/c 56000 Jan 1 Bank a/c 15000
Dec 31 Bank a/c 15000
Dec Interest a/c 2050 ,, Balance c/d 28050
31

58050 58050

II Balance b/d 28050 II

Jan 1
Goods repossessed a/c 29453
Interest a/c 1403 Dec 31
Dec
31 29453 29453

GOODS REPIOSSESSED A/C

Year II frs. Year frs.
Dec 31 P 29453 II
Cash (expenses) 357 Dec 31 Sales 30110
,, ,, 300
P & L a/c

30110 30110

P & L ACCOUNT
frs.

Goods repossessed A/c 300

Illustration 5
Roman transport & Co. purchased five trucks from Ramos Auto Ltd., on the January, 2011 on hire
purchase system. The cash price of each truck is 120,000 frs. The mode of payments was as follows:
 (i) 15% of cash price down
(ii) 25% of cash price at the end of each year for 4 year

Roman transport & Co. writes off 15% depreciation annually on diminishing balance. The payment
due to 31st December 2011 could not be made. Ramos Auto Ltd. agree to leave three Trucks with the
buyer on the conditions that the value of the other two Trucks would be adjusted against the amount
due, the trucks being valued at cost less 25% depreciation on diminishing balance.

Required: Show the necessary accounts in the books of Roman Transport & Co.

Solution
IN THE BOOKS OF ROMAN TRANSPORT & CO.

TRUCK ACCOUNT

2011 frs. 2011 frs.

Jan 1 To Ramons Auto Ltd. 600,000 Dec 31 Depreciation A/c 90,000
Balance c/d 510000
600000 600000
2012
Jan 1 Balance b/d 510000 2012 Depreciation A/c 76500
Dec 31 ,, Ramos Auto Ltd 135000
Profit & loss A/c
(loss on default)
(bal. fig ) 38400

Balance c/d 260100

510000 510000

2013
260000
Jan 1 To Balance b/d
 RAMOS AUTO LTD. ACCOUNT
2011 frs. 2011 frs.

Jan 1 Bank (15% of 600000) 90000 Jan 1 Truck a/c 600000

Bank a/c Dec 31 Interest a/c 36000

Dec 31 Balance a/c 150000

396000

636000 636000

2012 Truck a/c 2012

Dec 31 Balance c/d 135000 Jan 1 Balance b/d 396000

,, ,, 288000
Interest 27000

423000 423000

Working note:
Calculation of value of 2 Trucks taken up Ramos Auto Ltd.
frs.
Cost of 2 Trucks 240000
Less: depreciation @ 25% for 2011 60000
‐‐‐‐‐‐‐‐‐‐‐
180000
Less: depreciation @ 25% for 2012 45000
‐‐‐‐‐‐‐‐‐‐‐‐‐‐
Value on 31‐12‐2012 135000
‐‐‐‐‐‐‐‐‐‐‐‐‐‐
Calculation of value of 3 trucks retained by Roman Transport Co.
Cost of 3 trucks 360000
Less: depreciation @ 15% for 2011 54000
‐‐‐‐‐‐‐‐‐‐‐‐
306000
Less: depreciation @ 15% for 2012 45900
‐‐‐‐‐‐‐‐‐‐‐‐‐‐
260100
‐‐‐‐‐‐‐‐‐‐‐‐‐
Illustration 6

P purchased 4 cars of 14000 frs each on hire purchase system the hire purchase price for all the 4 cars
was 60000frs to be paid 15000frs down and 3 installment of 15000 frs each at the end of each year
interest is charged @ 5% p.a, buyer depreciates cars @10% p.a on straight line method.
After having paid down payment and first installment, buyer could not pay 2 nd installment and seller
took possession of three cars at an agreed value to be calculated after depreciating cars at 20%
p.a on written down value method one car was left with the buyer
Seller after spending 1200frs on repairs sold away all the three cars to X for 35000frs open ledger
accounts in the books of both parties

Solution

Calculation of value of asset taken by the seller

Number of cars taken by the seller =3
Cost price 3 x 14000 =
42000
Less: depreciation :
First year 8400
Second year 6720
‐‐‐‐‐‐‐‐‐‐‐ 15120
‐‐‐‐‐‐‐‐‐‐‐‐‐‐
Value of assets taken 26880
=========
Value of car left with buyer
Number of car = 1
Cost price = 14000
Less: depreciation:
First year 1400
Second year 1400
‐‐‐‐‐‐‐‐‐ 2800
‐‐‐‐‐‐‐‐‐‐‐
Value of asset left 11200
=========
 In the books of
P Asset
account

1st year By depreciation 5600

To hire vendor 56000 By balance c/d 50400
56000 56000
Second year
To balance b/d 50400 By depreciation 5600
By hire vendor 26880
By P&L account 6720
By balance c/d 11200
50400 50400

Hire vendor account

First year
To cash account 15000 By Assets account 56000
To cash 15000 By interest account 2050
To balance c/d 28050

58050 58050

To asset 26880 By balance 26880

To balance c/d 2573 b/d By 1403
interest
29453 29453

n the books of seller

P’s account
First year By cash a/c 15000
To sales account 56000 By cash a/c 15000
To interest 2050 By balance c/d 28050
58050 58050
Second year
To balance c/d 28050 By repossessed stock 26880
To interest 1403 By balance c/d 2573
29453 29453
 Repossessed stock account

To P’s account 26880 By cash 35000

To cash 1200
To P&L account 6920
35000 35000

INSTALMENT SYSTEM
It is a system of a sale in which the price of the article is paid in installments along with interest on
unpaid balances. Under this system the buyer gets the possession and ownership of the goods at the
time of signing agreements.

Difference between hire purchase and installment system

1) Hire purchase is agreements of hiring where as an installment system is an agreement of sale.

2) In the case of hire purchase system the ownership in the goods sold passes to the buyer only
on payment of the last installment. But in the case of installment system ownership passes to
the buyer immediately at the time of sale
3) If the buyer fails to pay any installment, the hire vendor can possess the goods. But in
installment system, the seller cannot possess the goods
4) The buyer can return goods sold to the seller, in the case of hire purchase. But in the
installment system, goods once sold cannot be returned
5) In the case of hire purchase system, the buyer cannot hire, sell, transfer or pledge the goods
until the full amount is paid. In the installment system, the buyer can hire sell, transfer or
pledge the goods before the payment of last installment
6) The risk of bad debt is relatively less in hire purchase transactions, but the risk of bad debt is
relatively more in installment system