Department of Finance and Accountancy

Vavuniya Campus of the University of Jaffna

Hire Purchase and Instalment System
Learning Objectives:
After completing this lesson you should be able to:
describe hire purchase and installment system
distinguish hire purchase and installment system
compute stock on hire and unrealized profit
Prepare accounts in the books of hire purchaser and hire purchase vendor
Introduction
The ultimate aim of a business unit is to market their products to ultimate consumers. If the
goods are of high value, then it is difficult for the consumers to buy them by paying the full
amount at same. Hence there is a practice among the business units to sell the products by
collecting a minimum amount of the price in the beginning and allow the buyers to repay the
amount in few Installments. The system of selling the goods by this method is called hire
purchase or Installments system.
Hire Purchase System
Hire Purchase is a system where the goods are sold on getting some minimum amount as
advance. The buyer is permitted to repay the balance amount in some fixed Installments. In
this system the goods are transferred immediately after the payment of the minimum amount.
But the title of the goods will not be transferred. The title will be transferred from the seller to
the buyer after the payment of the last installment by the buyer. The installments are treated
as hires for using the product by the buyer. If the buyer defaulted in the payment of the
installments, then the seller will take possession of the goods. The installments so far paid are
considered as the hires for using the product.
Installment System
Installment is a method of selling goods by receiving some minimum amount of the total
price of the goods as advance. The buyer has to repay the balance amount on installment
basis. In this method the title of the goods and the possession are transferred to the buyer as
soon as he paid the minimum amount in the beginning. If there is any default in the
repayment of installment, the title and possession will not be transferred from the buyer to the
seller. The amount of installment is decided ust like the amount in the hire purchase method.
The amount of installment is same for all the installments. It is calculated on the basis of
number of installments and interest with the help of annuity table.
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Important Concepts in Hire Purchase and Installment System
1 Cash Price
It is the actual price of a product. If the buyer is paying the full amount of the price of
the product it is called cash price. It is lower than the hire purchase or installment
price
! Hire Purchase price or Installment Price
It is the price at which goods are sold to the customers by accepting a minimum
amount of the total price as advance. It is higher than the cash price since the seller is
taking the risk of collecting the amount of installments for longer period. The increase
is due to the component of interest
" Do#n payment
!own payment is the amount paid in the beginning at the time of transferring the
possession of the goods. The amount is normally about "#$ to %#$ of the hire price.
It is decided on the basis of the mutual agreement of the seller and buyer. !own
payment is compulsory both for the sales under hire purchase system and installment
system. This amount is deducted from the total hire price &Installment price' of the
goods, to determine the fixed installments.
$ Installments
It is the number of periods permitted by the seller to repay the balance amount of the
price of the product purchased on hire purchase basis or Installments may be annually
half yearly (uarterly or monthly basis. The amount of installment is normally the
same for the all the periods.
Distinction %et#een Hire Purchase system and Installment System
The important differences between hire purchase and Installment systems are as follows)
i. The parties in Hire Purchase *ystem are called hire purchaser and hire vendor. The
parties is Installment system are called seller and buyer
ii. In hire purchase system the title of the goods is not transferred due to down payment.
It will be transferred only after the payment of the last Installment. Installment system
the title of the goods is transferred immediately after the down payment
iii. The relationship of seller and buyer in hire purchase system is bailor and bailee. *uch
kind of relationship does not exist in the Installment
iv. +oss of goods in hire purchase system in considered as a loss for the seller. Buyer is
not responsibility of such loss. +oss of goods in Installment system is considered as a
loss for the buyer. *eller is not responsible for such loss
v.In hire purchase system, if there is any default in the repayment of Installments by the
buyer the seller can take possession of the goods. The installments so far paid are
considered as a hire charge for using the product by the buyer. If there is any default in
the payment of the installments as installment system the seller could not take
possession of the goods. The seller can persuade the buyer to pay the dues or he can
approach a court for getting the dues from the buyer
vi. The buyer can terminate the contract in hire purchase system. The seller will take
possession the goods in such situation. The seller need not pay any amount to the buyer
as compensation. But in the Installment system, the contract could not be terminated
either by the buyer or seller
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Accountin& for Hire Purchase System
Hire purchase transactions are involved with two parties namely the buyer and seller. Buyer
and seller are called in Hire Purchase system Hire purchaser and Hire ,endor respectively.
The Hire purchaser and Hire vendor prepare accounts separately in their books.
Accountin& of Hire Purchase 'ransactions in the (oo) of Hire Purchaser
Hire purchaser maintaining books of -ournal and ledger. .ormally two /ethods are used to
record transactions in the book of Hire purchaser. They are stated as follows)
(nder the hire purchase system the title of the asset !ill not be transferred to the hire
purchaser until the last installment is paid" #ut$ !hen preparing accounts in the boo%s of
hire purchaser the asset is recorded in the value of cash price and depreciation is provided
on that value&
*ethod I
De%it
+s
Credit
+s
1 Cash Price,
0ssets 0ccount
!r 1111
HP ,endor 0ccount2*upplier 0ccount
3r 1111
! Do#n payment,
HP ,endor4s 0ccount !r 1111
3ash2Bank 0ccount 3r 1111
" Hire Purchase Interest accrued
HP interest 0ccount
!r 1111
HP ,endor4s 0ccount
3r 1111
$ Payment of HP installment
HP ,endor4s 0ccount !r 1111
3ash2Bank 0ccount 3r 1111
- Depreciation Provision ...
!epreciation 0ccount
!r 1111
0ssets 0ccount
3r 1111
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5hen preparing balance sheet, the credit balance in the hire purchase ,endor4s account may
either be deducted from the balance in the asset or shown as a current liability.
/0ample11
0 +td purchased a /achine on the hire purchase system from B +td on 6
st
-anuary "##7 by
paying 8s.6##,### as down payment and agreed to pay the balance in #% e(ual annual
installments of 8s "##,###. The payment s are done at the end of each financial year. The
cash selling price was 8s 9:;,%;6. The rate of interest was 6#$ per annum.
!epreciation was calculated < 6#$ per annum on written down value..
Prepare necessary -ournal =ntries and +edger accounts in the books of 0 +td
Calculation of interest and the amount paid for capital,
particulars Cash price Interest Installment paid for
capital
3ash Price 9:;,%;6
!own Payment &6##,###'
Balance cash price >:;,%;6 >:,;%; "##,### 69#,"?%
6st installment &paid for 3apital' &69#,"?%'
Balance cash price %>;,6#7 %>,;66 "##,### 6?9,"7:
"nd installment &paid for 3apital' 6?9,"7:
Balance cash price 676,76: 67,676 "##,### 676,76:
%nd installment &paid for 3apital' 676,76:
Balance cash price #
Date Particulars De%it2+s3 Credit 2+s3
6@6@"##7 /achinery 0ccount !r 9:;,%;6
B +td 3r 9:;,%;6
&Being /achinery Purchased'
6@6@"##7 B +td !r 6##,###
Bank 0ccount 3r 6##,###
&Being down payment paid'
%6@6"@"##7 Interest 0ccount !r >:,;%;
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B +td 3r >:,;%;
&Being accrued interest debited'
%6@6"@"##7 B +td !r "##,###
Bank 0ccount 3r "##,###
&Being first installment paid'
%6@6"@"##7 !epreciation of machinery 0ccount !r 9:,;%;
/achinery 0ccount 3r 9:,;%;
&being depreciation provided
%6@6"@"##7 Profit and +oss 0ccount !r 6#:,>;>
Interest 0ccount 3r >:,;%;
!epreciation of machinery 0ccount 3r 9:,;%;
&being interest and depreciation
charged to PA+ account'
%6@6"@"##: Interest 0ccount !r %>,;66
B +td 3r %>,;66
&Being accrued interest debited'
%6@6"@"##: B +td !r "##,###
Bank 0ccount 3r "##,###
&Being first installment paid'
%6@6"@"##: !epreciation of machinery 0ccount !r 9%,;?%
/achinery 0ccount 3r 9%,;?%
&being depreciation provided
%6@6"@"##: Profit and +oss 0ccount !r 77,>;>
Interest 0ccount 3r %>,;66
!epreciation of machinery 0ccount 3r 9%,;?%
&being interest and depreciation
charged to PA+ account'
%6@6"@"#6# Interest 0ccount !r 67,676
B +td 3r 67,676
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&Being accrued interest debited'
%6@6"@"#6# B +td !r "##,###
Bank 0ccount 3r "##,###
&Being first installment paid'
%6@6"@"#6# !epreciation of machinery 0ccount !r >7,%7;
/achinery 0ccount 3r >7,%7;
&being depreciation provided
%6@6"@"#6# Profit and +oss 0ccount !r ??,9?7
Interest 0ccount 3r 67,676
!epreciation of machinery 0ccount 3r >7,%7;
&being interest and depreciation
charged to PA+ account'
*ethod II
In the method '$ hire vendor is credited for the cash price of the goods" #ut in the method
''$ vendor is credited for the hire purchase price of the goods purchased" (he asset is
debited for the cash price" Hence$ the difference is debited !ith the interest suspense
account" )hen every installment is paid the interest accrued is credited to the suspense
account"
De%it
+s
Credit
+s
1 Hire Purchase Price2Cash Price 4 'otal Interest3
0ssets 0ccount &3ash Price'
!r 1111
Interest *uspense 0ccount
!r 1111
HP ,endor 0ccount2*upplier 0ccount
3r 1111
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! Do#n payment,
HP ,endor4s 0ccount
!r 1111
3ash2Bank 0ccount
3r 1111
" Hire Purchase Interest accrued
HP interest 0ccount
!r 1111
Interest *uspense 0ccount
3r 1111
$ Payment of HP installment
HP ,endor4s 0ccount !r 1111
3ash2Bank 0ccount 3r 1111
- Depreciation Provision ...
!epreciation 0ccount
!r 1111
0ssets 0ccount
3r 1111
5hen preparing balance sheet, the debit balance in the interest suspense 0ccount is deducted
from the hire purchase ,endor4s account.
The net balance in the hire purchase ,endor4s account may either be deducted from the
balance in the asset or shown as a current liability.
/0ample1!
!ara +td purchased a 5ashing /achine from 8aveendir +td on 6
st
-anuary "##7 for 8s
>%#,9##. The cash selling price was 8s %##,###. The terms were an initial deposit of 8s
6##,### followed by #% annual installments on %6
st
!ecember "##7, "##: and "#6# of 8s
66#,### 8s 66#,### and 66#,9## respectively. The rate of interest was %#$ per annum.
!epreciation was calculated < "#$ per annum on a straight line basis.
Prepare necessary -ournal =ntries and +edger accounts in the books of !ara +td
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