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Accounting for Hire Purchase

>> July 27, 2011

Hire purchase is an agreement between two parties in which one party purchase any asset from other party. Because he has no money to pay, so he pays per month hire charges. Vendor has the possession of asset. When buyer pays total price of assets in the form of hire charges, then asset is transferred to its purchaser. Vendor may  also transfer asset before last payment of installment on his own risk. If buyer will become defaulter, vendor has right to get his asset from hire purchaser.

Accounting Methods for Hire Purchase Transaction 

For accounting point of view both hire purchase and  instalment payment system are same. Before accounting, we should know following things

a) Cash price is that price which will be paid if any asset is purchased on cash without installment.

b) Hire price = cash price + interest for risk of giving asset on instalment.

c) Down payment = Payment at the beginning of deal of hire purchase.
There are four methods of accounting for hire purchase.

1st Method : Cash Price Method 

Under cash price method, we are deal hire purchase transactions just like normal transactions. When transactions or event happen, we record them.

Journal Entries in the books of Purchaser

a) For buying assets on hire purchase

Asset on hire purchase account Dr.

Vendor account Cr.

b) For paying the down payment to vendor

Vendor account Dr

Cash/ bank

c) When Interest is Due on unpaid installments

Interest on Hire Purchase account Dr.

Vendor Account Cr.

d) For Instalment Payment  ( Interest payment will be also included in it)

Vendor Account Dr

Cash / Bank account Cr

e) For transferring interest to profit and loss account 

Profit and Loss account Dr.

Interest on hire purchase account Cr.

f) For depreciation charge

Depreciation account Dr.

Assets on hire purchase account Dr.

g) If Asset is returned

Hire Vendor account Dr.

Asset  on hire purchase account Cr.

In the books of Hire Vendor

a) For giving assets on hire

Hire purchaser account Dr.

H.P. Sale Cr.

b) For down payment received

Bank account Dr.

H.P. Sales Cr.

c) For Interest receivable

Hire purchaser account Dr.

Interest account Cr.

d) For installment due

Installment due account Dr.

H.P. Sales Cr.

e) For installment received

Bank account Dr.

Hire purchaser account Cr.

f) For installment not due at the year

Hire purchase stock account Dr.

Trading account Cr.

g) For stock reserve 

Stock Reserve account Dr.

Hire purchase stock account Cr.

Disclosure in balance sheet

Current Assets

Hire purchase debtor XXXX

2nd Method  Interest Suspense Method

In this method, we open interest suspense account. All the interest which is not paid on hire purchase asset will go to  interest suspense account. When interest will become due, interest account will be debit and interest suspense account will credit.

following entries will pass in the books of hire buyer

a) For transferring total interest payable on hire purchase deal

Interest suspense account Dr.

Hire purchase account Cr.

b) When interest is due 

interest account Dr.

interest suspense account Cr.

all other entries will be same as first method.

In the books of hire vendor

a) For transferring total interest payable to interest suspense account

hire purchaser account Dr..

interest suspense account Cr.

b) when interest is due

interest suspense account Dr.

interest account Cr.

all journal entries will be same of first method

Disclosure in the balance sheet

Current Assets

Hire purchase debtors

Less balance in interest suspense account

3rd Method :  Trading Method

In this method, the hire purchase trading account is prepared in the book of vendor of asset in the form of hire purchase system.

4th Method : Stock and Debtor Method

In this method, hire purchase stock, hire purchase debtor and hire purchase adjustment account are maintained. Following entries will pass in the books of vendor

a) When goods are sold on hire purchase

hire purchase stock account Dr. ( Hire purchase price)

stock account Cr. ( Actual cost of sale of goods )

hire purchase adjustment account Cr. ( difference between hire purchase price and actual cost )

b)When installments become due for payment

hire purchase debtors account Dr.

hire purchase stock account Cr.

c) When cash is received

Cash account Dr.

Hire purchase debtor account Cr.

d) stock reserve account on opening stock

stock reserve account Dr.

hire purchase adjustment account Cr.

e) Stock reserve on closing stock

Hire purchase adjustment account Dr.

Stock reserve account Cr.

{Important Note : This topic will also continue in future with explaining some examples. So, be alert for this topic.}

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swapnil sahasrabuddhe February 5, 2014 at 10:16 AM  

But which method I should follow while solving the problem? Wll it be given in exam or I ve to understand as per my knowledge? Let me know

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