Hire Purchase and Instalment

System
 Introduction
• It is not always possible by a purchaser to
meet up the higher demand for goods due to
immediate cash payment.

• To meet this demand the concept of Hire

purchase is very popular in the market.
• Under this system the purchaser (Hirer) pays the entire amount in
staggered way viz. monthly, quarterly or yearly with some interest.
• Under this system the goods are sold with the following conditions.

• Possession of goods is delivered to a hirer but the title to the goods

(Ownership) are transferred only when the agreed sum( Hire Purchase
price) is paid by the hirer.
• Such hirer has a right to terminate the agreement at any time before the
property so passes.
• That means he has the option to return the goods in which case he need
not pay installments falling due thereafter.
• However, the hirer cannot recover the sums already paid as such sums
legally represent hire charges of the goods in question.
• The hire-purchaser, during that period of possession of goods, cannot
damage, destroy, pledge or sell such goods.
• He is supposed to take all such care of goods as a prudent person does in
his own goods.

• In case of Installment sale, it is not only the possession of goods but also
the ownership in goods is transferred to the buyer immediately at the time
of agreement.
• Further, in installment system if the buyer stops the payment of dues, then
He does not have the right of seizing his goods.
Differences between installment sale and hire-purchase
 SITUATION I : WHEN RATE OF INTEREST, TOTAL CASH PRICE AND INSTALLMENTS
ARE GIVEN

• Illustration 1 : X purchases a car on hire-purchase system on

1.1.07. The total cash price of the car is Rs. 4,50,000 payable
Rs. 90000 down and three installments of Rs. 1,70,000, Rs.
1,50,000 and Rs. 1,08,460 payable at the end of first, second
and third year respectively. Interest is charged at 10% p.a.
• You are required to calculate interest paid by the buyer to the
seller each year.
 SITUATION II : WHEN RATE OF INTEREST AND
INSTALLMENTS ARE GIVEN BUT
TOTAL CASH PRICE IS NOT GIVEN
• X purchased a T.V on hire-purchase system. As per
terms he is required to pay Rs. 3000 down,
• Rs. 4000 at the end of first year, Rs. 3000 at the end
of second year, and Rs. 5000 at end of third year.
Interest is charged at 12% p.a.
• You are required to calculate total cash price of T.V
and interest paid with each install ment.
 SITUATION III: -WHEN ONLY INSTALLMENTS
ARE GIVEN, BUT CASH PRICE AND
RATE OF INTEREST ARE NOT GIVEN
• Illustration 3 :
• X & Co. purchased a Motor car on April 1, 2007 on
hire-purchase paying Rs. 60,000 cash down and
balance in four annual installments of Rs. 55,000, Rs.
50,000.,Rs. 45000 and Rs. 40,000 each Installment
comprising equal amount of cash price at the end of
each accounting period.
• You are required to calculate total cash price and
amount of interest in each Installment.
SITUATION IV: WHEN REFERENCE TO ANNUITY TABLE RATE OF INTEREST AND
INSTALLMENTS ARE GIVEN BUT TOTAL CASH PRICE IS NOT GIVEN.

• In such questions the reference to annuity table gives

the present value of the annuity for a number of
years at a certain rate of interest.
• This present worth is equal to total cash price.
• Therefore, with the help of annuity tables the total
cash price of the total installments given can be
calculated and then question can be solved by the
first method.
 Accounting treatment.
Accounting treatment in the books of buyer and seller

• The following methods are followed:

• (1) Cash Price Method
• (2) Interest Suspense Method
• Cash Price Method:
• Under this method, we will have to prepare
the following ledger accounts:
• (i) H.P. Asset Account.
• (ii) Hire Vendor Account.
Accounting Entries:
Interest Suspense Method:
 In the Books of Vendor
• Goods which are sold under HP system may be classified into two categories.
• They are
• (A) Items of large value and long life which buyers treat as fixed assets and
• (B) Small consumer items which are purchased by general public such as radios, TV sets, tape
• recorders, fans, washing machines, etc.
• The buyers of such items being general public do not make any accounting entries. The accounting
methods depend on the nature of goods sold.

• Let us discuss the accounting treatment for large items.

• (A) Large items: In the case of hire-purchase sales there are three components in the selling
• price as shown below:
• (1) Cost Price
• + (2) Gross Profit = Cash Price
• + (3) Interest = Hire-Purchase sales price.
• The accounting methods generally recognize gross profit at the point of sale. Regarding interest
• there are two methods.
• (1) Sales Method.
• (2) Interest Suspense Method.
• Sales Method :
• Under this method, interest is recognized only when the instalment is due.
• Accounting Entries:
• Interest Suspense Method :
In this method the total interest is credited to interest suspense account and is
transferred to interest account proper at the end of each accounting period.
 DEFAULT AND REPOSSESSION
• When hirer is in default in making payments in time, the owner takes back the
possession of goods. There are two possibilities:
• (a) Complete repossession When seller takes back the possession of complete goods.
• Accounting treatment in this case is as follows:
• Books of Purchaser
• 1. All entries, except the entry for payment, are passed as usual up to the date of
• default.
• 2. Buyer closes the account of seller by debiting his account. The same amount will be
• credited to asset account.
• 3. Any balance left in asset account is closed by transferring to profit and loss account.
• Books of Seller
• 1. All entries, except the entry for payment, are passed as usual up to the date of
• default.
• 2. Seller closes purchaser’s account by crediting his account (by the amount credit given)
• and debiting goods returned account (a new account).
• 3. Goods returned account, as opened, is further debited with expenses incurred on
repair of the goods and credited with actual resale price. Any balance in this account,
being profit or loss on resale, is transferred to profit and loss account.
• Illustration 4 :
• X purchased a truck for Rs. 2,80,000, payment to be made Rs.
91,000 down and 3 installments of Rs. 76,000 each at the end
of each year. Rate of interest is charged at 10% p.a. Buyer
depreciates assets at 15% p.a. on written down value method.
• Because of financial difficulties, X, after having paid down
payment and first installment to the end of 1st year could not
pay second installment and seller took possession of the
truck. Seller, after spending Rs. 9,200 on repairs of the asset
sold for Rs. 150,000. Show the relevant accounts in the books
of the purchaser & the vendor.
• b) Partial Repossession - When seller takes possession of only part of
the total asset sold to buyer.
• In this case accounting entries in the books of both the parties are similar to those
done in the first case. The additional precautions to be taken are as follows:
• (i) Both buyer and seller do not close seller’s and buyer’s account in their respective
• books. The entry is passed with the agreed value of the asset which is taken away by
• the seller. The basis for finding out the value of asset taken away is given in the
question.
• (ii) The buyer finds out the value of asset still left with him using the normal rate of
• depreciation. He keeps the asset account open. This account shows the balance of that
• asset which is left to him by the seller
• (iii) After crediting the asset account (in buyer’s books) with the value of asset taken
away by the seller (with such value as agreed upon) and after keeping the balance of
the asset left [normal value as calculated in (ii) above], the difference shown by the
asset account represents either profit or loss on default. This difference is transferred to
profit and loss account.
• Illustration 5 :
• Z Ltd. purchased seven trucks on hire purchase on 1st July, 2005. The
cash purchase price of each truck was Rs 1,00,000.
• The company has to pay 20% of the cash purchase price at the time of
delivery and the balance in five half yearly instalment starting from 31st
December, 2005 with interest at 5% per annum at half yearly rest.
• On the Company's failure to pay the instalment due on 30th June 2006,
it was agreed that the Company would return 3 trucks to the vender and
the remaining four would be retained.
• The vendor agreed to allow him a credit for the amount paid against
these 3 trucks less 25%.

• Show the relevant Accounts in the books of the purchase and vendor
assuming the books are closed in June every year and depreciation @
20% p.a. is charged on Trucks. Vendor after spending Rs. 2,000 on
repairs sold away all the three trucks for Rs. 80,000.
• Illustration 6 :
• HT Ltd. purchased three electric motors costing Rs. 10,000 each from KM Ltd on
1st January, 2004 on the hire purchase system.
• The terms were : Payment on delivery Rs 2,500 for each motor and balance of the
principal amount by 3 equal instalments plus interest at 15% per annum to be
paid at the end of each year.
• HT. Ltd writes off 25% depreciation each year on the diminishing balance method.
HT. Ltd failed to pay the last instalment. KM. Ltd repossessed two motors
adjusting values against the amount due.
• The repossession was done on 1st January, 2007 on the basis of 40% depreciation
on the diminishing balance method.
• You are required to:
• (a) Write up the ledger accounts in the books of H.T. Ltd showing the above
transactions upto 1.1.2007, and
• (b) Show the disclosure of the balance arising from the above in the Balance
Sheet of H.T. Ltd an on 31st December 2006.
• Illustration 7 :
• On 1.1.2004, B & Co. bought 5 computers from Chirag Computers on hire-
purchase. The cash price of each computer was Rs 20,000.
• It was agreed Rs 30,000 each at the end of each year. The Vendor charges
interest @ 10% p.a. The buyer depreciates computers at 20% p.a. on the
diminishing balance method.
• B & Co. paid cash down of Rs. 5,000 each and two instalments but failed
to pay the last instalment. Consequently, the Computers Co. repossessed
three sets, leaving two sets with the buyer and adjusting the value of 3
sets against the amount due.
• The sets repossessed were valued on the basis of 30% depreciation p.a. on
the written down value. The sets repossessed were sold by the Chirag
Computers for Rs 30,000 after necessary rapairs amounting to Rs 5,000 on
30th June 2007.
• Required : Open the necessary ledger account in the books of both the
parties.
Thanks