"Hire Purchase System": Introduction, Definitions, Characteristics, Advantages, Disadvantages, Differences, Process of Accounting,

Key Points:

1. Introduction of Hire Purchase System.
2. Definitions of Hire Purchase System.
3. Characteristics of Hire Purchase System.
4. Advantages of Hire Purchase System.
   (A) Advantages to Purchaser,
   (B) Advantages to Seller.
5. Disadvantages of Hire Purchase System.
   (A) Disadvantages to Purchaser,
   (B) Disadvantages to Seller.
6. Differences between Hire Purchase and Credit Purchase.
7. Process of Accounting under Hire Purchase System
   (A) In the Books of Hire Purchaser.
   (B) In the books of Hire Vendor.

8. The Accounting Procedure related to “Default and Repossession” of goods sold under Hire Purchase System.

9. Entries are made “In Case of Repairs Borne by Hire Vendor Free of Cost”.

 

Link : https://smckk14.blogspot.com/2022/09/deprecation-methods-6-method-of.html

1. Introduction of Hire Purchase System:

It is a specific system of purchase and sales of goods. Under this system, the purchaser acquires the possession of the goods immediately and agrees to pay the total hire purchase price in instalments, these instalments maybe monthly, quarterly, half yearly or yearly or any other period as mentioned in the agreement. each instalment is treated as a hire charge until the payment of last instalment.

In case the purchaser makes any default in payment of any instalment, the seller has a right to repossess the goods from the purchaser and to forfeit the amount already received treating as hire charge. The Purchaser becomes the owner of the goods only after payment of last instalment.

This system is beneficial to both the parties i.e. purchaser and seller. The purchaser gets the facility of paying the total price of the goods in instalments and seller is able to sell more goods receiving the price in instalments with a security to repossess the goods in case of purchaser makes default in case of payment of any instalment.

2. Definitions of Hire Purchase System:

According to J.R. Batliboi: "Under the hire purchase system goods are delivered to a person (Purchaser) who agrees to pay the owner (Seller) by equal periodical instalments. Each instalment is treated as hire of the goods, and on payment of a certain number in instalments, the goods become property of the hirer".

According to Section 2 (c) of Hire Purchase Act 1972: "Hire Purchase Agreement means an agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of the agreement and includes an agreement under which (i) Possession of goods is delivered by the owner to a person on a condition that such person pays agreed amount of periodical instalments, and (ii) The property in the goods is to pass to such person on the payment of the last of such instalments and (iii) Such person has a right to terminate the agreement at the time before the property to passes".

3. Characteristics of Hire Purchase System:

(i) Agreement -

Hire Purchase System is an agreement between two parties i.e. between Hire purchaser and Hire vendor /seller.

(ii) Credit Sale -

It is a type of credit sales where full value of goods is not paid immediately but paid in instalments during a particular time interval.

(iii) Instalment -

The full value of the goods is paid in instalments. The amount and period of instalments are determined by agreement.

(iv) Right to use the goods -

On payment of first instalment by the purchaser, goods are transferred by seller to the purchase where purchaser obtains the right to use the goods but ownership of the goods remains with the seller.

(v) Ownership of the goods -

Though right to use the goods vests with the purchaser, ownership of the goods remains with the seller till the last payment of the instalment.

(vi) Duty of Hire Purchaser -

This is the duty of hire purchaser to keep the goods in good condition up to the date of final instalment.

(vii) Duty of Hire Vendor -

This is the duty of hire vendor to make normal repairs free of cost up to the date of final instalment.

(viii) Liability of Guarantor -

If there is any guarantor in hire purchase agreement, in case of non-payment of any instalment, the seller has a right to recover the amount from guarantor.

(ix) Default in Payment by Purchaser -

If the Purchaser commits default in payment of instalments on the due dates, the seller will have the right to repossess the goods and to forfeit the amount paid by purchaser. Such forfeited amount will be treated as hire charge.

4. Advantages of Hire Purchase System:

(A) Advantages to Purchaser:

(i) Availability of costly goods -

In this system price of the goods is paid in number of instalments, it becomes convenient for the purchaser so he can use the costly goods available in the market.

(ii) Facility to return goods -

If utility of the goods reduces, the purchaser has an option to return the goods and get the agreement cancelled.

(iii) Facility of free of cost repairing of goods -

Ownership of goods remains with the seller till the payment of final instalment, so it is the duty of the seller to get the goods repaired free of cost.

(iv) Economical -

In this system, if instalments are not paid properly, goods are returned to the seller. This provision makes the purchaser auctions regarding payment of each instalment so he tries to make more savings for paying the instalments on time.

(v) Easy Payment -

The price of the goods is to be paid in instalments, payment because becomes very easy and simple and unnecessary burden of making payment in lump sum is avoided.

(B) Advantages to Seller:

(i) Increase in Sale Volume -

Under this system, payment is to be made in easy instalments. So, other person who do not have sufficient money to make purchase in lump sum, also purchase the goods. Ultimately, sale volume increases.

(ii) Regular Income -

Hire purchaser makes the regular payment of instalments under the pressure that the goods might be taken back by seller in case of default in payment of instalments.

(iii) Receiving more amount -

The seller not only receive the cash price of the goods but interest there on also.

(iv) Healthy relationship -

This system increases the healthy relationship between purchaser and seller which may result in increase in sale in future.

5. Disadvantages of Hire Purchase System:

(A) Disadvantages to Purchaser:

(i) Payment of more amount -

The purchaser has to pay cash price plus interest thereon for the goods.

(ii) No right to Sell or Mortgage -

The ownership of the goods remains with the seller till the payment of final instalment. So, the purchaser can neither sell or mortgage the goods till the payment of final instalment.

(iii) Unnecessary Purchases -

The payment under this system is made in easy instalments which induces the consumers to purchase even unnecessary goods.

(B) Disadvantages to Seller:

(i) Difficulty in Recovery of Instalments -

Sometimes, seller of the goods has to face many difficulties to recover the instalments from the purchaser which create dispute between both the parties.

(ii) Difficulty in Repossessing the Goods -

Under the provisions of this system, the seller can repossess the goods sold by him, from the purchaser, if the Purchaser makes default in payment of any instalment but in practice, it is not too easy.

(iii) Loss of Depreciation -

When the goods are to be repossessed from purchaser, the seller has to bear the loss of depreciation on the asset.

(iv) More Capital Required -

In this system, payment of the goods sold is received in instalments, so to maintain stock level, seller requires a large amount of capital which is not possible for every seller.

(v) Burden of Repairs –

The responsibility of making repairs to the asset lies with the seller till the last instalment is received. so, the seller has to bear burden on repairing of the goods sold.

6. Differences between Hire Purchase and Credit Purchase:

S.No.	Hire Purchase	Credit Purchase
1.	Ownership is transferred after payment of final instalment.	Ownership is transferred at the time of purchase.
2.	Burden of repairs lies with the seller.	Burden of repairs lies with the purchaser.
3.	Payment is made in instalments always.	payment is made in lump sum or as agreed upon.
4.	In case of defaults in payment of instalment, seller has no right to repossess the goods.	Seller has no right to repossess the goods. He can claim only for outstanding amount.
5.	Seller is protected under the system.	Purchaser is protected under this system.
6.	The third party cannot get better title on the goods, till last instalment is not paid.	Third party may get better title on this system.

7. Process of Accounting under Hire Purchase System:

There are two methods for making accounting entries of the hire purchase transactions in the books of Hire purchaser -

(A) In the Books of Hire Purchaser:

First method: “Assets Accrual Method”:

This method is used by hire purchaser who considers that he has become owner of that portion of the goods for which payment has been made.

Particular	L.F.	Amt.	Amt.
Asset A/c  Dr.   To Cash /Bank A/c (Being the amount of cash down payment)

 

Particular	L.F.	Amt.	Amt.
Asset A/c  Dr. (Cash price of the asset) Interest A/c  Dr. (Amt. of interest)   To Hire Vendor A/c (Total instalment) (Being the first instalment due)

 

Particular	L.F.	Amt.	Amt.
Hire Vendor A/c  Dr.   To Cash /Bank A/c (Being payment of first instalment)

 

Particular	L.F.	Amt.	Amt.
Depreciation A/c  Dr.   To Asset A/c (Being depreciation charged)

 

Particular	L.F.	Amt.	Amt.
Profit & Loss A/c  Dr.   To Depreciation A/c   To Interest A/c (Being depreciation & interest accounts closed by transferring to Profit & Loss A/c)

Note: 1. Entries (ii) to (v) will be repeated in subsequent years.

2. Asset will be shown in Balance Sheet at purchase price less depreciation.

Second Method: "Credit Purchase Method":

This method is used by the hire purchaser who treats hire purchase as real purchase.

Particular	L.F.	Amt.	Amt.
Asset A/c  Dr. (Cash price of the asset)   To Hire Vendor A/c (Being asset is purchased on hire purchase system)

 

Particular	L.F.	Amt.	Amt.
Hire Vendor A/c  Dr.   To Bank A/c (Being cash down payment on delivery)

 

Particular	L.F.	Amt.	Amt.
Interest A/c  Dr.   To Hire Vendor A/c (Being interest due at the end of the year)

 

Particular	L.F.	Amt.	Amt.
Hire Vendor A/c  Dr.   To Bank A/c (Being payment of first instalment)

 

Particular	L.F.	Amt.	Amt.
Depreciation A/c  Dr.   To Asset A/c (Being depreciation charged on asset)

 

Particular	L.F.	Amt.	Amt.
Profit & Loss A/c  Dr.   To Depreciation A/c   To Interest A/c (Being depreciation & interest accounts closed by transferring to Profit & Loss A/c)

Note: 1. Entries (iii) to (vi) will be repeated in subsequent years.

2. Asset shown in the Balance Sheet after deducting depreciation and balance due to the vendor from the beginning balance of asset.

(B) In the books of Hire Vendor:

There is only one method of making accounting record in the books of Hire Vendor.

Particular	L.F.	Amt.	Amt.
Hire purchaser’s A/c  Dr.   To Hire Sales A/c (Being goods sold on hire purchase system)

 

Particular	L.F.	Amt.	Amt.
Bank A/c  Dr.   To Hire purchaser’s A/c (Being cash down payment received)

 

Particular	L.F.	Amt.	Amt.
Hire purchaser’s A/c  Dr.   To Interest A/c (Being interest due on instalment at the end of the year)

 

Particular	L.F.	Amt.	Amt.
Bank A/c  Dr.   To Hire purchaser’s A/c (Being amount of first instalment received)

 

Particular	L.F.	Amt.	Amt.
Interest A/c  Dr.   To Profit & Loss A/c (Being interest amount closed by transferring to Profit & Loss A/c)

Note: 1. Entries (iii) to (v) will be repeated in subsequent years.

2. No entry for depreciation is made in the books of Hire Vendor because the asset has been transferred to Hire Purchaser.

8. The Accounting Procedure related to “Default and Repossession” of goods sold under Hire Purchase System:

When the purchaser commits any default in payment of any instalment, the vendor has a right to repossess the goods sold and forfeit the amount which he has already been received from purchaser treating it as hire charge. There may be two conditions in repossession of goods –

(i) When Vendor Repossesses all the Goods Sold:

Under this condition, journal entries regarding interest and depreciation are recorded in the books of hire purchaser and hire vendor excluding the entry for payment up to the date of default.

The hire purchaser closes the account of hire vendor by transferring the balance to asset account by debiting the hire vendor’s account and crediting the asset account.

The hire vendor closes the account of hire purchaser by transferring the balance to goods repossess account. This account is debited with repairing expenses etc. and credited with sale price, if any. The balance shows profit or loss on repossessed goods and is closed by transferring to Profit and Loss account.

(ii) When the hire vendor repossesses apart of goods sold -

Under this condition, journal entry regarding interest and depreciation are recorded in the books of hire purchaser excluding the entry for payment up to the date of default.

The hire purchaser does not close hire vendor’s account and hire vendor does not close hire purchaser’s account in their books but an entry is made with the agreed value of the asset which has been repossessed by the hire vendor. Normally, the hire vendor agrees to repossess apart of asset with enhance rate of depreciation.

The hire purchaser calculates the value of asset remained with him at normal rate of depreciation and keeps this amount as balance carried down in asset account. The balance of asset account shows profit or loss on default and transferred to profit and loss account.

9. Entries are made “In Case of Repairs Borne by Hire Vendor Free of Cost”:

When goods are sold by hire vendor, he assures hire purchaser that repairs will be done by him (hire vendor) free of cost up to a certain period. The anticipated amount of expense is included in purchase price. Hire vendor opens maintenance suspense account in his books.

Following journal entries are made in the books of hire vendor -

Particular	L.F.	Amt.	Amt.
Hire Purchaser A/c  Dr.   To Hire Sales A/c (Being sales made including maintenance charges)

 

Particular	L.F.	Amt.	Amt.
Hire Sales A/c  Dr.   To Maintenance Suspense A/c (Being transfer of maintenance charges to maintenance suspense A/c)

 

Particular	L.F.	Amt.	Amt.
Hire Purchaser A/c  Dr.   To Interest A/c (Being interest due on asset sold)

 

Particular	L.F.	Amt.	Amt.
Bank A/c  Dr.   To Hire Purchaser A/c (Being instalment received)

 

Particular	L.F.	Amt.	Amt.
Maintenance Suspense A/c  Dr.   To Cash A/c (Being actual cost of maintenance paid)

 

Particular	L.F.	Amt.	Amt.
Profit & Loss A/c  Dr.   To Maintenance Suspense A/c (Being excess of actual cost of maintenance transferred to Profit & Loss A/c)

 

Particular	L.F.	Amt.	Amt.
Maintenance Suspense A/c  Dr.   To Profit & Loss A/c (Being excess of maintenance suspense transferred to Profit & Loss A/c)

 

Particular	L.F.	Amt.	Amt.
Interest A/c  Dr.   To Profit & Loss A/c (Being interest transferred to Profit & Loss A/c)

Note: Interest is calculated on cost price including the amount of repairs.