Class 3 - Hire Purchase

HIRE PURCHASE
is a means of buying assets that avoids the need to pay in full either at the time of purchase or
very soon thereafter.
The essential differences between a hire purchase and a ‘normal’ purchase are:
1. The asset does not belong to the purchaser when it is received from the supplier. Instead it
belongs to the supplier providing the hire purchase.
2. The purchaser will pay for the item by instalments over a period of time. This may be for as
long as two or three years, or even longer.
3.The cost to the buyer will be higher than it would have been had the item been paid for at the
time of purchase. The extra money paid is for interest.
4.The asset does not legally belong to the purchaser until two things happen:
(a) the final instalment is paid.
(b) the purchaser agrees to a legal option to buy the asset.
Interest payable on hire purchase.

Each payment made on a hire purchase contract consists of two things:
1 Capital. Paying off some of the amount owing for the cash price of the asset.
2 Interest. Paying off some of the interest that has accrued since the last instalment was paid.
The total payment (1) + (2) made for each instalment may be the same, or may differ.
Accounting for Hire Purchase

Accounting treats assets bought on hire purchase as though they belonged immediately to the
purchaser. This is because businesses normally buy assets on hire purchase with the intention
of paying all the instalments, so that the asset finally will belong to them.
As they mean to keep the asset and legally own it on the final payment, accounting enters it as
though legal ownership occurred on purchase.
This is an illustration of the use of the ‘substance over form’ concept. Legally the firm does not
yet own the asset (form) yet it does own it from an economic perspective (substance).
The total purchase price is split into two parts for the financial statements:
1 Cash price. This is the amount to be debited to the fixed asset account.
2 Interest. This is an expense of borrowing money and needs charging to an expense account,
i.e. hire purchase interest account. As interest accrues over time, each period.
DOUBLE ENTRY
The double entry needed is:
(A) Cash price: Dr Fixed asset Account
Cr Supplier Account
(B) Hire purchase interest: Dr Hire purchase interest account:
Cr Supplier account
(C) Hire purchase instalments: Dr Supplier Account
Cr Cash Book Account
(D) Charge interest to profit and loss: Dr Profit and loss Account
Cr Hire purchase interest Account
Depreciation and assets bought on Hire Purchase

Depreciation is based on the cash price. Hire purchase interest is an expense in the profit and
loss account and so does not enter depreciation calculations. Balance sheets and assets bought
on hire purchase In the balance sheet for a sole trader or partnership, fixed assets being bought
on hire purchase can be shown as follow
Examples
Buyers Book
A machine is bought by K Thomas for £3,618, hire purchase price, from Suppliers Ltd on 1
January 20X3. It is paid by 3 instalments of £1,206 on 31 December of 20X3, 20X4 and 20X5.
The cash price is £3,000. Rate of interest is 10 per cent. Straight line depreciation of 20 per cent
per annum is to be provided.
Required
Prepare the following ledger accounts as they would appear in the buyer’s books.
a) Machine account
b) Suppliers Limited account
c) Hire purchase interest account.
d) Provision for depreciation account.
Sellers Book
The machine was sold on 1 January 20X3 to K Thomas on hire purchase terms. Cash price was
£3,000 plus hire purchase interest. Hire purchase interest was at a rate of 10 per cent. There
are to be three instalments of £1,206 each, receivable on 31 December of 20X3, 20X4 and 20X5.
These were paid by K Thomas on the correct dates. This was the only hire purchase sale during
the three years. The profit on the cash price is to be shown as profits for 20X3, the year in
which the sale was made. The cost of the machine to Suppliers Ltd was £2,100.
Required
Prepare the following accounts as the would appear in seller’s books:
a) Hire Purchase Sales account
b) Thomas account
c) HP interest account
d) Cost of Hire Purchase Goods account
e) Cash book account
Repossessions
When customers stop paying their instalments before they should do, the goods can be taken
away from them. This is called repossession. The amounts already paid by the customers will
be kept by the seller. The repossessed items should be entered in the books of the seller, as
they are now part of his stock, but they will not be valued as new stock. The items must be
valued as used goods.
Accounting for leases and hire purchase contracts

Leasing and Hire purchase contracts are means by which companies acquire the right to use
(lease) or purchase (hire purchase) fixed assets.
Normally no provision in a lease contract for legal title to the leased asset to pass to the lessee
during the term of a lease in contrast under a hire purchase contract the hirer may acquire legal
title by exercising an option to purchase the asset upon fulfilment of certain conditions
(normally the payment of an agreed number of instalments).
Lessors fall into three broad categories:

(i) Companies, including banks and finance houses, which provide finance under lease
contracts to enable a single customer to acquire the use of an asset for the greater part
of its useful life.
(ii) They may operate a business which involves the renting out of assets for varying
periods of time probably to more than one customer.
(iii) They may be manufacturer or dealer lessors who use leasing as a means of marketing
their products, which may involve leasing a product to one customer or to several
customers.
As a lessor and lessee are both parties to the same transaction
Lessor is the supplier of an asset. Lessee is the beneficially of the asset.
TYPES OF LEASES
There are two types of leases: finance leases and operating leases. The distinction between a
finance lease and an operating lease will usually be evident from the contract between the
lessor and the lessee.
Finance lease: usually involves repayment to a lessor by a lessee of the full cost of the asset
together with a return on the finance provided by the lessor. As such, a lease of this type is
normally non-cancellable or cancellable only under certain conditions, and the lessee enjoys
substantially all the risks and rewards associated with the ownership of an asset, other than
the legal title. (This is very similar to a hire purchase contract.)
Operating lease: involves the lessee paying a rental for the hire of an asset for a period of time
which is normally substantially less than its useful economic life. The lessor retains the risks
and rewards of ownership of an asset in an operating lease and normally assumes
responsibility for repairs, maintenance and insurance.
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Class 3 - Hire Purchase

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Class 3 - Hire Purchase

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HIRE PURCHASE

Interest payable on hire purchase.

Accounting for Hire Purchase

Depreciation and assets bought on Hire Purchase

Accounting for leases and hire purchase contracts

Lessors fall into three broad categories:

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