Chap 11 Hire Purchase and Instalment Sale Transactions PDF
Chap 11 Hire Purchase and Instalment Sale Transactions PDF
Chap 11 Hire Purchase and Instalment Sale Transactions PDF
CHAPTER OVERVIEW
Hire Purchase Accounting: Under Hire Purchase System, hire purchaser pays the cost
of purchased asset in number of instalments. The ownership of the goods is transferred
by the Hire Vendor only after payment of outstanding balance.
Installment System: Under Installment System also, the purchaser pays the cost of
purchased asset in number of installments. However, under installment system,
ownership of the goods is transferred by owner on the date of delivery of the goods
Methods of Accounting
1. INTRODUCTION
With an increasing demand for better life, the consumption of goods has been on the
expanding scale. But, this has not been backed up by adequate purchasing power,
transforming it into effectual demand, i.e., actual sale at set or settled prices. This has
created the market for what is called hire purchase.
When a person wants to acquire an asset, but is not sure how to make payment within
a stipulated period of time he may pay in instalments if the vendor agrees. This enables
the purchaser to use the asset while paying for it in instalments over an agreed period
of time. This type of a business deal is known as hire purchase transaction. Here, the
customer pays the entire amount either in monthly or quarterly or yearly instalments,
while the asset remains the property of the seller until the buyer squares up his entire
liability. For the seller, the agreed instalments include his interest on the assets given
on credit to the purchaser. Therefore, when the total amount (being paid in instalments
over a period of time) is certainly higher than the cash down price of the asset because
of interest charges. Obviously, both the parties gain in the bargain. By virtue of this,
the purchaser has the right of immediate use of the asset without making immediate
payment for the asset, by this, he gets both credit and product from the same seller.
From seller’s view point, he derives the benefits by way of increase in sales and also he
recovers his own cost of credit.
instalments are payable. The interest will be calculated first on the 4th instalment, then
on the 3rd instalment, then on the 2nd instalment and lastly on the 1st instalment.
Interest on down payment will be nil.
In this connection, it should be noted that the amount of interest will go on increasing
from the 4th instalment to the 3rd instalment, from the 3rd instalment to the 2nd
instalment and from the 2nd instalment to the 1st instalment.
We know that interest is to be calculated on the outstanding balance of cash price.
In this case, we will have to calculate the interest with the help of the total amount
due on hire purchase price since the cash price is not known. For the purpose of
calculating the interest, the following steps should be followed:
Step 1 : Calculate the ratio between interest and the amount due with the help of the
following formula :
Step 2 : Calculate the interest included in the last instalment by applying the following
formula:
Interest = Total amount due at the time of instalment x Ratio of interest and
amount due (as calculated in step 1)
Step 3 : Subtract the interest (as calculated in step 2) from this instalment to get the
amount of outstanding cash price at the time of last instalment.
Step 4 : Add the cash price calculated in Step 3 to the amount of instalment due at
the end of the third year.
Step 5 : Calculate the interest on the entire sum (cash price included in the 4th
instalment + amount of 3rd instalment). Deduct this interest from the total
amount due at the end of 3rd year to get the outstanding cash price at the
time of 3rd instalment.
Step 6 : Add the cash price calculated in step 5 to the amount of instalment due at
the end of 2nd year.
Step 7 : Calculate the interest on the entire sum so obtained in Step 6. Deduct
this interest from the total amount due at the end of 2nd year to get the
outstanding cash price at the time of 2nd instalment.
Step 8 : Add the cash price calculated in Step 7 to the amount of instalment due at
the end of 1st year.
Step 9 : Calculate the interest on the entire sum so obtained in Step 8. Deduct
this interest from the total amount due at the end of 1st year to get the
outstanding cash price at the time of 1st instalment.
Step 10 : Add the cash price calculated in Step 9 to the amount of down payment, if
any. The sum so obtained will be the total cash price.
Illustration 1
Asha purchased a truck on hire purchase system. As per terms she is required to pay
` 70,000 down, ` 53,000 at the end of first year, ` 49,000 at the end of second year and
` 55,000 at the end of third year. Interest is charged @ 10% p.a.
You are required to calculate the total cash price of the truck and the interest paid with
each instalment.
Solution.
(1) Ratio of interest and amount due = 100Rate of interest = 10 = 1
+ Rate of interest 110 11
(2) Calculation of Interest and Cash Price
No. of Amount due at the
Interest Cash price
instalments time of instalment
[1] [2] [3] [4]
3rd 55,000 1/11 of ` 55,000 = ` 5,000 50,000
2nd *99,000 1/11 of ` 99,000 = ` 9,000 90,000
1st **1,43,000 1/11of ` 1,43,000 = ` 13,000 1,30,000
Illustration 2
A acquired on 1st January, 20X1 a machine under a Hire-Purchase agreement which
provides for 5 half-yearly instalments of ` 6,000 each, the first instalment being due on
1st July, 20X1. Assuming that the applicable rate of interest is 10 per cent per annum,
calculate the cash value of the machine. All working should form part of the answer.
Solution
Statement showing cash value of the machine acquired on hire-purchase basis
Instalment Interest @ 5% half yearly Principal
Amount (10% p.a.) = 5/105 = 1/21 Amount (in each
(in each instalment) instalment)
` ` `
5th Instalment 6,000 286 5,714
Less: Interest (286)
5,714
Add: 4th Instalment 6,000
11,714 558 5,442
Less: Interest (558) (6,000 – 558)
11,156
Add: 3rd instalment 6,000
17,156 817 5,183
Less: Interest (817) (6,000 – 817)
16,339
Add: 2nd instalment 6,000
22,339 1,063 4,937
Less: Interest (1,063) (6,000 – 1,063)
21,276
Add: 1st instalment 6,000
27,276 1,299 4,701
Less: Interest (1,299) _______ (6,000 –1,299)
25,977 4,023 25,977
The cash purchase price of machinery is ` 25,977.
5.2 Calculation of Total Cash Price with the help of Annuity Table
Cash price = Down payment + Present value of instalments
Present value of instalments is calculated as follows:
(a) If present value of an annuity of ` 1 for a given period, at given rate of interest,
is given Present value of instalments = Annual instalments x Present value of an
annuity of ` 1 for a given period at given rate of interest
(1 + r) n - 1
= Annual instalment ×
r (1 + r) n
(b) If annuity to recover ` 1 during a given period at given rate of interest is given
(1 + r) n - 1
= Annual instalment x
r (1 + r) n - 1
Illustration 3
On 1st April, 20X1 a manufacturing company buys on Hire-purchase system a machinery
for ` 90,000, payable by three equal annual instalments combining principal and interest,
the rate of interest was 5% per annum. Calculate the amount of cash price and interest.
Assume that the present value of an annuity of one rupee for three years at 5% interest
is ` 2.723.
Solution
Calculation of Cash Price : The present value of an annuity of Re. 1 paid for 3 year
@ 5% = ` 2.723. Hence, the present value of ` 30,000 for 3 years = 2.723 x 30,000 =
` 81,690.
Thus, Cash Price will be computed as ` 81,690.
Cash price may also be calculated using the annuity formula discussed above:
(1 + r) n - 1
Cash price = Annual instalment ×
r (1 + r) n
= 30,000 x [(1 + 0.05)3 – 1]/ 0.05 (1 + 0.05)3
= ` 81,697.
Note : The difference in cash price of ` 7 is on account of approximation.
6. ASCERTAINMENT OF INTEREST
We know that the hire purchase price consists of two elements: (i) cash price; and (ii)
interest. Cash price is an expenditure incurred for the acquisition of an asset towards
payment of capital (principal) amount and interest is a expense in the nature of revenue
for delay in making the full payment. Ascertainment of any of these two gives the
answer for the other, e.g., if we ascertain the total amount of interest, it becomes very
simple to ascertain the cash price just by deducting the amount of interest from the
hire purchase price.
Interest is charged on the amount outstanding. Therefore, if the hire purchaser makes
a down payment on signing the contract, it will not include any amount of interest. It
should be noted that though the instalments of a hire purchase agreement may be
equal, the interest element in each instalment is not the same.
At the time of calculating interest, students may face the following two situations:
(a) When the cash price, rate of interest and the amount of instalments are given; and
(b) When the cash price and the amount of instalments are given, but the rate of
interest is not given.
Now, let us consider the above two situations.
6.1 When the cash price, rate of interest and the amount of instalments are given
In this situation, the total amount of interest is to be ascertained first. It is the difference
between the hire purchase price (down payment + total instalments) and the cash
price. To calculate the amount of interest involved in each instalment the following
steps are followed:
Step 1 : Deduct down payment from the cash price. Calculate the interest at the given
rate on the remaining balance. This represents the amount of interest included
in the first instalment.
Step 2 : Deduct the interest of Step 1 from the amount of first instalment. The resultant
figure is the cash price included in the first instalment.
Step 3 : Deduct the cash price of the 1st instalment (Step 2) from the balance due after
down payment. It represents the amount outstanding after the 1st instalment
is paid.
Step 4 : Calculate the interest at the given rate on the balance outstanding after the
1st instalment. Deduct this interest from the amount of the 2nd instalment to
get the cash price included in the 2nd instalment.
Step 5 : Deduct the cash price of the 2nd instalment (Step 4) from the balance due
after the 1st instalment. It represents the amount outstanding after the 2nd
instalment is paid.
Repeat the above steps till the last instalment is paid.
Illustration 4
Om Ltd. purchased a machine on hire purchase basis from Kumar Machinery Co. Ltd. on
the following terms:
(a) Cash price ` 80,000
(b) Down payment at the time of signing the agreement on 1.1.20X1 ` 21,622.
(c) 5 annual instalments of ` 15,400, the first to commence at the end of twelve months
from the date of down payment.
(d) Rate of interest is 10% p.a.
You are required to calculate the total interest and interest included in cash instalment.
Solution:
Calculation of interest
Total Interest in each Cash price in each
(`) instalment (1) instalment (2)
Cash Price 80,000
Less : Down Payment (21,622) Nil ` 21,622
Balance due after down payment 58,378
Interest/Cash Price of 1st instalment - ` 58,378 x10/100 ` 15,400 – ` 5,838
= ` 5,838 = ` 9,562
Less : Cash price of 1st instalment (9,562)
Balance due after 1st instalment 48,816
Interest/cash price of 2nd instalment - ` 48,816 x ` 15,400 - ` 4,882
10/100 = ` 10,518
= ` 4,882
Less: Cash price of 2nd instalment (10,518)
Balance due after 2nd instalment 38,298
Interest/Cash price of 3rd instalment - ` 38,298x10/100 ` 15,400 - ` 3,830
= ` 3,830 = ` 11,570
Less: Cash price of 3rd instalment (11,570)
Balance due after 3rd instalment 26,728
6.2 When the cash price and the amount of instalments are given, but the rate of
interest is not given
When the rate of interest is not given, but the cash price and the amount of installments
are given, we have to find interest rate implicit in the transaction by bifurcating the
installments between reduction in liability and finance charges (interest).
· For detailed understanding of IRR, students are advised to refer Financial Management Study Material.
Internal rate of return (IRR) is the discount rate that equates the present value of the
expected net cash outflows (amount of down-payment and installments) with the
cash price. When the net cash flows are not uniform over the life of the investment,
the determination of the discount rate can involve trial and error and interpolation
between interest rates.
In case of hire purchase, Internal Rate of Return Method (IRR)· method considers the
time value of money, the cash price, and all cash outflows (amount of down-payment
and installments) relating to the purchase of the asset on hire purchase basis. IRR
method does not use the desired rate of return but estimates the discount rate that
makes the present value of subsequent net cash outflows equal to the cash price.
Illustration 5
Happy Valley Florists Ltd. acquired a delivery van on hire purchase on 01.04.20X1 from
Ganesh Enterprises. The terms were as follows :
Particulars Amount (`)
Hire Purchase Price 180,000
Down Payment 30,000
1st installment payable after 1 year 50,000
2nd installment after 2 years 50,000
3rd installment after 3 years 30,000
4th installment after 4 years 20,000
Cash price of van ` 1,50,000 You are required to calculate Total Interest and Interest
included in each instalment.
Solution :
Calculation of total Interest and Interest included in each installment
Hire Purchase Price (HPP) = Down Payment + instalments
= 30,000 + 50,000 + 50,000 + 30,000 + 20,000 = 1,80,000
Total Interest = 1,80,000 – 1,50,000 = 30,000
Computation of IRR (considering two guessed rates of 6% and 12%)
Year Cash Flow DF @6% PV DF @12% PV
0 30,000 1.00 30,000 1.00 30,000
1 50,000 0.94 47,000 0.89 44,500
2 50,000 0.89 44,500 0.80 40,000
3 30,000 0.84 25,200 0.71 21,300
4 20,000 0.79 15,800 0.64 12,800
NPV 1,62,500 NPV 1,48,600
Accounting
To have proper accounting record, one should know: (1) Date of purchase of the asset;
(2) Cash price of the asset; (3) Hire purchase price of the asset; (4) The amount of down
payment; (5) Number and amount of each instalment; (6) Rate of interest; (7) Method
and rate of depreciation; (8) Date of payment of every instalment; and (9) Date of
closing the books of account.
Journal Entries
Illustration 6
On January 1, 20X1 HP M/s acquired a Pick-up Van on hire purchase from FM M/s. The
terms of the contract were as follows:
(a) The cash price of the van was ` 1,00,000.
(b) ` 40,000 were to be paid on signing of the contract.
(c) The balance was to be paid in annual instalments of ` 20,000 plus interest.
(d) Interest chargeable on the outstanding balance was 6% p.a.
(e) Depreciation at 10% p.a. is to be written-off using the straight-line method.
You are required to:
(a) Give Journal Entries and show the relevant accounts in the books of HP M/s
from January 1, 20X1 to December 31, 20X3; and
(b) Show the relevant items in the Balance Sheet of the purchaser as on December
31, 20X1 to 20X3.
Solution.
In the books of HP M/s
Journal Entries
Date Dr. Cr.
` `
20X1 Pick-up Van A/c Dr. 1,00,000
Jan. 31 To FM M/S A/c 1,00,000
(Being the purchase of a pick-up van on hire purchase
from FM M/s)
“ FM M/S A/c Dr. 40,000
To Bank A/c 40,000
(Being the amount paid on signing the H.P. contract)
Dec. 31 Interest A/c Dr. 3,600
To FM M/s A/c 3,600
(Being the interest payable @ 6% on ` 60,000)
“ FM M/s A/c (` 20,000+` 3,600) Dr. 23,600
To Bank A/c 23,600
(Being the payment of 1st instalment along with
interest)
“ Depreciation A/c Dr. 10,000
To Pick-up Van A/c 10,000
(Being the depreciation charged @ 10% p.a. on
` 1,00,000)
FM M/s Account
Date Particulars ` Date Particulars `
1.1.20X1 To Bank A/c 40,000 1.1.20X1 By Pick-up Van A/c 1,00,000
31.12.20X1 To Bank A/c 23,600 31.12.20X1 By Interest c/d 3,600
31.12.20X1 To Balance c/d 40,000
1,03,600 1,03,600
31.12.20X2 To Bank A/c 22,400 1.1.20X2 By Balance b/d 40,000
31.12.20X2 To Balance c/d 20,000 31.12.20X2 By Interest A/c 2,400
42,400 42,400
31.12.20X3 To Bank A/c 21,200 1.1.20X3 By Balance b/d 20,000
31.12.20X3 By Interest A/c 1,200
21,200 21,200
Depreciation Account
Date Particulars ` Date Particulars `
31.12.20X1 To Pick-up Van A/c 10,000 31.12.20X1 By Profit & Loss A/c 10,000
31.12.20X2 To Pick-up Van A/c 10,000 31.12.20X2 By Profit & Loss A/c 10,000
31.12.20X3 To Pick-up Van A/c 10,000 31.12.20X3 By Profit & Loss A/c 10,000
Interest Account
Date Particulars ` Date Particulars `
31.12.20X1 To FM M/s A/c 3,600 31.12.20X1 By Profit & Loss A/c 3,600
31.12.20X2 To FM M/s A/c 2,400 31.12.20X2 By Profit & Loss A/c 2,400
31.12.20X3 To FM M/s A/c 1,200 31.12.20X3 By Profit & Loss A/c 1,200
Illustration 7
In illustration 6 assume that the hire purchaser adopted the interest suspense method for
recording his hire purchase transactions. On this basis, prepare H.P. Interest Suspense
Account, Interest Account and FM M/s Accounts and Balance Sheets in the books of hire
purchaser.
Solution
H.P. Interest Suspense Account
Date Particulars ` Date Particulars `
1.1.20X1 To FM M/s A/c (W.N.) 7,200 31.12.20X1 By Interest A/c 3,600
31.12.20X1 By Balance c/d 3,600
7,200 7,200
1.1.20X2 To Balance b/d 3,600 31.12.20X2 By Interest A/c 2,400
31.12.20X2 By Balance c/d 1,200
3,600 3,600
1.1.20X3 To Balance b/d 1,200 31.12.20X3 By Interest A/c 1,200
Interest Account
Date Particulars ` Date Particulars `
31.12.20X1 To H.P. Interest 3,600 31.12.20X1 By Profit & Loss A/c 3,600
Suspense A/c
31.12.20X2 To H.P. Interest 2,400 31.12.20X2 By Profit & Loss A/c 2,400
Suspense a/c
31.12.20X3 To H.P. Interest 1,200 31.12.20X3 By Profit & Loss A/c 1,200
Suspense A/c
FM M/s Account
Date Particulars ` Date Particulars `
1.1.20X1 To Bank A/c 40,000 1.1.20X1 By Pick-up Van A/c 1,00,000
31.12.20X1 To Bank A/c 23,600 1.1.20X1 By H.P. Interest 7,200
Suspense A/c
31.12.20X1 To Balance c/d 43,600
1,07,200 1,07,200
31.12.20X2 To Bank A/c 22,400 1.1.20X2 By Balance b/d 43,600
31.12.20X2 To Balance c/d 21,200
43,600 43,600
31.12.20X3 To Bank A/c 21,200 1.1.20X3 By Balance b/d 21,200
Balance Sheet of HP M/s as at 31st December, 20X1
Liabilities ` Assets `
FM M/s 43,600 Pick-up Van 1,00,000
Less: H.P. Interest (3,600) 40,000 Less: Depreciation (10,000) 90,000
Suspense
Balance Sheet of HP M/s as at 31st December, 20X2
Liabilities ` Assets `
FM M/s 21,200 Pick-up Van 90,000
Less: H.P. Interest (1,200) 20,000 Less: Depreciation (10,000) 80,000
Suspense
Balance Sheet of HP M/s as at 31st December, 20X3
Liabilities ` Assets `
Pick-up Van 80,000
Less: Depreciation (10,000) 70,000
Working Note:
Total Interest = ` 3,600 + ` 2,400 + ` 1,200 = ` 7,200.
7.2 In the books of the Hire Vendor
There are two methods of recording hire purchase transactions in the books of the hire
vendor. The selection of the method is based on the type and value of goods sold,
volume of transactions, the length of the period of purchase, etc. These two methods
are as follows:
Sales Method
A business that sells relatively large items on hire purchase may adopt this method.
Under this method, hire purchase sale is treated as a credit sale. The only exception
is that the vendor agrees to accept payments in instalments and for that he charges
interest. Generally, a special Sales Day Book is maintained for recording all sales under
hire purchase agreement. The amount due from the hire purchaser at the end of the
year is shown in the Balance sheet on the assets side as Hire Purchase Debtors.
Journal Entries
1. When goods are sold and delivered under hire purchase
Hire Purchaser Account Dr. [Full cash price]
To H.P. Sales Account
2. When the down payment is received
Bank Account Dr.
To Hire Purchaser Account
3. When an instalment becomes due
Hire Purchaser Account Dr.
To Interest Account
4. When the amount of instalment is received
Bank Account Dr.
To Hire Purchaser Account
5. For closing interest Account
Interest Account Dr.
To Profit and Loss Account
Liabilities Liabilities
Amount payable to Vendor
Less: Balance in Interest Suspense A/c
8. REPOSSESSION
In a hire purchase agreement, the hire purchaser has to pay up to the last instalment to
obtain the ownership of goods. If the hire purchaser fails to pay any of the instalments,
the hire vendor takes the asset back in its actual form without any refund of the earlier
payments to the hire purchaser. The amounts received from the hire purchaser through
down payment and instalments are treated as the hire charges by the hire vendor. This
act of recovery of possession of the asset is termed as repossession.
Repossessed assets are resold to any other customer after repairing or reconditioning
(if necessary). Accounting figures relating to repossessed assets are segregated from
the normal hire purchase entries. Repossessions are then accounted for in a separate
“Goods Repossessed Account”.
So far as the repossession of assets are concerned, the hire vendor can take back the
whole of the asset or a part thereof depending on the agreement between the parties.
The former is called “Complete Repossession” and the latter is called “Partial
Repossession”.
Repossession
Miscellaneous Illustrations
Illustration 8
X Ltd. purchased 3 milk vans from Super Motors costing ` 75,000 each on hire purchase
system. Payment was to be made: ` 45,000 down and the remainder in 3 equal instalments
together with interest @ 9%. X Ltd. writes off depreciation @ 20% on the diminishing
balance. It paid the instalment at the end of the 1st year but could not pay the next.
Super Motor agreed to leave one milk van with the purchaser, adjusting the value of the
other two milk vans against the amount due. The milk vans were valued on the basis of
30% depreciation annually on written down value basis. X Ltd. settled the seller’s dues
after three months.
You are required to give necessary journal entries and the relevant accounts in the books
of X Ltd.
Solution
In the Books of X Ltd.
Journal Entries
Dr. (`) Cr. (`)
I Year
Milk Vans purchased:
Milk Vans A/c Dr. 2,25,000
To Vendor A/c 2,25,000
On down payment:
Vendor A/c Dr. 45,000
To Bank 45,000
I Year end
Interest A/c (` 1,80,000 @ 9%) Dr. 16,200
To Vendor A/c 16,200
Vendor A/c Dr. 76,200
To Bank A/c (60,000 + 16,200) 76,200
Depreciation @ 20%
Depreciation A/c Dr. 45,000
To Milk Vans A/c 45,000
Profit & Loss A/c Dr. 61,200
To Depreciation 45,000
To interest A/c 16,200
II Year end
Depreciation @ 20%
Depreciation A/c Dr. 36,000
To Milk Vans A/c 36,000
Interest A/c Dr. 10,800
(1,20,000 @ 9%)
To Vendor A/c 10,800
For Loss in Repossession:
Super Motors A/c (1,50,000 – 45,000 – 31,500) Dr. 73,500
Profit/Loss A/c (b.f.) Dr. 22,500
To Milk Vans A/c [(2,25,000 – 45,000 – 36,000) x 2/3] 96,000
IIIrd Year Depreciation
Depreciation A/c (48,000 x 20%) Dr. 9,600
To Milk Vans A/c 9,600
Settlement of A/cs
Vendor A/c Dr. Dr. 57,300
To Bank 57,300
Year ` Year `
1 To Super Motors A/c 2,25,000 1 end By Depreciation A/c 45,000
” By Balance c/d 1,80,000
2,25,000 2,25,000
2 To Balance b/d 1,80,000 2 end By Depreciation 36,000
By Super Motors (value of 73,500
2 vans after depreciation
for 2 years @ 30%)
By P & L A/c (balancing 22,500
figure)
By Balance c/d (one van 48,000
less depreciation for 2
years) @ 20%
1,80,000 1,80,000
Illustration 9
A firm acquired two tractors under hire purchase agreements, details of which were as
follows:
Date of Purchase Tractor A Tractor B
1st April, 1st Oct.,
20X1(`) 20X1 (`)
Tractor A 2,100*
Tractor B 950** 3,050
3,050 3,050
20X2 ` 20X2 `
June30 To Disposal of Tractor 2,850 Jan. 1 By Balance b/d 3,050
account—Transfer
(950 + 1,900)
Jun. 30 By P & L A/c
Dec. 31 To Balance c/d 4,900 (Depn. for Tractor B) 1,900
(19,000 x 20% x 6/12)
Dec. 31 By P & L A/c
(Depn. for Tractor A) 2,800
(14,000 x 20%)
7,750 7,750
20X3
Jan. 1 By Balance b/d 4,900
Illustration 10
A machinery is sold on hire purchase. The terms of payment is four annual instalments
of ` 6,000 at the end of each year commencing from the date of agreement. Interest is
charged @ 20% and is included in the annual payment of ` 6,000.
Show Machinery Account and Hire Vendor Account in the books of the purchaser
who defaulted in the payment of the third yearly payment whereupon the vendor re-
possessed the machinery. The purchaser provides depreciation on the machinery @ 10%
per annum on WDV basis. All workings should form part of your answers.
Solution
Machinery Account
` `
I Yr. To Hire Vendor A/c (W.N.) 15,533 I Yr. By Depreciation A/c 1,553
By Balance c/d 13,980
15,533 15,533
II Yr. To Balance b/d 13,980 II Yr. By Depreciation A/c* 1,398
By Balance c/d 12,582
13,980 13,980
III Yr. To Balance b/d 12,582 III Yr. By Depreciation A/c* 1,258
By Hire Vendor 11,000
By Profit & Loss A/c 324
(Loss on Surrender) (bal.
fig.)
12,582 12,582
*Depreciation has been directly credited to the Machinery Account; it could have been
accumulated in provision for depreciation account.
Hire Vendor Account
` `
I Yr. To Bank A/c 6,000 I Yr. By Machinery A/c 15,533
To Balance c/d 12,639 By Interest A/c 3,106
18,639 18,639
II Yr. To Bank A/c 6,000 II Yr. By Balance b/d 12,639
To Balance c/d 9,167 By Interest A/c 2,528
15,167 15,167
III Yr. To Machinery A/c (transfer) 11,000 III Yr. By Balance b/d 9,167
By Interest A/c 1,833
11,000 11,000
Note : Alternatively, total interest could have been debited to Interest Suspense A/c
and credited to Hire Vendor A/c with consequential changes.
Working Notes:
Instalment Interest Principal
Amount ` `
4th Instalment 6,000
20
Interest 6,000 x 120 1,000 1,000 5,000
5,000
Add : 3rd Instalment 6,000
11,000
20
Interest 11,000 x 120 1,833 1,833 4,167
9,167
Add : 2nd Instalment 6,000
15,167
20
Interest 15,167 x 120 2,528 2,528 3,472
12,639
Add : Ist Instalment 6,000
18,639
20
Interest 18,639 x 120 3,106 3,106 2,894
Illustration 11
X Transport Ltd. purchased from Delhi Motors 3 Tempos costing ` 50,000 each on the
hire purchase system on 1-1-20X1. Payment was to be made ` 30,000 down and the
remainder in 3 equal annual instalments payable on 31-12-20X1, 31-12-20X2 and
31-12-20X3 together with interest @ 9%. X Transport Ltd. writes off depreciation at the
rate of 20% on the diminishing balance. It paid the instalment due at the end of the first
year i.e. 31-12-20X1 but could not pay the next on 31-12-20X2. Delhi Motors agreed
to leave one Tempo with the purchaser on 1-1-20X3 adjusting the value of the other 2
Tempos against the amount due on 31-12-20X2. The Tempos were valued on the basis
of 30% depreciation annually. Show the necessary accounts in the books of X Transport
Ltd. for the years 20X1, 20X2 and 20X3.
Solution
X Transport Ltd.
Tempo Account
` `
20X1 20X1
Jan. 1 To Delhi Motors 1,50,000 Dec.31 By Depreciation A/c : 30,000
20% on 1,50,000
By Balance c/d 1,20,000
1,50,000 1,50,000
20X2 20X2
Jan. 1 To Balance b/d 1,20,000 Dec.31 By Depreciation A/c 24,000
By Delhi Motors A/c 49,000
(Value of 2 tempos
taken away)
By Profit and Loss A/c
[(96,000 x 2/3) – 15,000
49,000]
By Balance c/d (Value 32,000
of one tempo left)
(W.N.1)
1,20,000 1,20,000
20X3 20X3
Jan. 1 To Balance b/d 32,000 Dec.31 By Depreciation A/c 6,400
By Balance b/d 25,600
32,000 32,000
20X2 20X2
Jan. 1 To Tempo 49,000 Jan. 1 By Balance b/d 80,000
Dec.31 To Balance c/d 38,200 Dec.31 By Interest (9% on 7,200
` 80,000)
87,200 87,200
20X3 ` 20X3 `
Dec.31 To Bank 41,638 Jan. 1 By Balance b/d 38,200
Dec.31 By Interest (9% on 3,438
` 38,200)
41,638 41,638
Working Notes :
(1) Value of a Tempo left with the buyer:
`
Cost 50,000
Depreciation @ 20% p.a. under WDV method for
2 years [i.e. ` 10,000 + ` 8,000] (18,000)
Value of the Tempo left with the buyer at the end of 2nd year 32,000
`
Cost ` 50,000 × 2 = 1,00,000
Depreciation @ 30%
Under WDV method for 2 years [i.e. ` 30,000 + ` 21,000 ] (51,000)
Value of tempos taken away at the end of 2nd year 49,000
by instalments and the risk that he thereby undertakes. It is thus made up of following
elements:
(a) cash price;
(b) interest on unpaid instalments; and
(c) a charge to cover the risk involved in the buyer de¬faulting to pay one or more of
instalments of price or that of his returning the goods in a damaged condition.
Interest is the charge for the facility to pay the price for the goods by instalments after
they have been delivered. The rate of interest is generally higher than that payable in
respect of an advance or a loan since it also includes a charge to cover the risk that
the hirer may fail to pay any of the instalments and, in such an event, the goods may
have to be taken back into possession in whatever condition they are at the time. A
separate charge on this account is not made as that would not be in keeping with the
fundamental character of the hire-purchase sale.
3. Passing of Title (ownership) The title to goods passes on The title to goods passes
last payment. immediately as in the case
of usual sale.
4. Right to Return goods The hirer may return Unless seller defaults, goods
goods without further are not returnable.
payment except for accrued
instalments.
5. Seller’s right to repossess The seller may take The seller can sue for price
possession of the goods if if the buyer is in default. He
hirer is in default. cannot take possession of
the goods.
6. Right of Disposal Hirer cannot hire out sell, The buyer may dispose
pledge or assign entitling off the goods and give
transferee to retain good title to the bona fide
possession as against the purchaser.
hire vendor.
7. Responsibility for Risk of The hirer is not responsible The buyer is responsible
Loss. for risk of loss of goods if for risk of loss of goods
he has taken reasonable because of the ownership
precaution because the has transferred.
ownership has not yet
transferred.
8. Name of Parties involved The parties involved are The parties involved are
called Hirer and Hire vendor. called buyer and seller.
9. Component other than cash Component other than Cash Component other than Cash
price. Price included in installment Price included in Installment
is called Hire charges. is called Interest.
SUMMARY
Under Hire Purchase System, hire purchaser will pay cost of purchased asset in
installments. The ownership of the goods will be transferred by the Hire Vendor
only after payment of outstanding balance.
Under installment system, ownership of the goods is transferred by owner on the
date of delivery of goods.
Accounting for hire purchase transactions
• Hire purchaser’s books
√ Cash price Method
√ Interest suspense method
• Hire vendor’s books
√ Sales Method
√ Interest suspense method
Theoretical Questions
1. What is meant by Hire purchase transactions? What are the specific features of
hire purchase transactions?
2. What are the differences between Hire Purchase and Instalment System?
Practical Questions
Question 1
A acquired on 1st January, 20X1 a machine under a Hire-Purchase agreement which
provides for 5 half-yearly instalments of ` 6,000 each, the first instalment being due on
1st July, 20X1. Assuming that the applicable rate of interest is 10 per cent per annum,
calculate the cash value of the machine. All working should form part of the answer.
Question 2
On 1st April, 20X1, Fastrack Motors Co. sells a truck on hire purchase basis to Teja
Transport Co. for a total hire purchase price of ` 9,00,000 payable as to ` 2,40,000 as
down payment and the balance in three equal annual instalments of ` 2,20,000 each
payable on 31st March 20X2, 20X3 and 20X4.
The hire vendor charges interest @ 10% per annum.
You are required to ascertain the cash price of the truck for Teja Transport Co.
Calculations may be made to the nearest rupee.
Question 3
Lucky bought 2 tractors from Happy on 1-10-20X1 on the following terms:
`
Down payment 5,00,000
1st installment at the end of first year 2,65,000
2nd installment at the end of 2nd year 2,45,000
3rd installment at the end of 3rd year 2,75,000
Interest is charged at 10% p.a.
Lucky provides depreciation @ 20% on the diminishing balances.
On 30-9-20X4 Lucky failed to pay the 3rd installment upon which Happy repossessed
1 tractor. Happy agreed to leave one tractor with Lucky and adjusted the value of the
tractor against the amount due. The tractor taken over was valued on the basis of 30%
depreciation annually on written down basis. The balance amount remaining in the
vendor's account after the above adjustment was paid by Lucky after 3 months with
interest @ 18% p.a.
ANSWERS/ HINTS
MCQs
1. (b) 2. (a) 3. (b) 4. (c) 5. (c) 6. (b)
7. (c)
Theoretical Questions
1. Under the Hire Purchase System, the Hire Purchaser gets possession of the goods
at the outset and can use it, while paying for it in instalments over a specified
period of time as per the agreement. However, the ownership of the goods
remains with the Hire Vendor until the hire purchaser has paid all the instalments.
For specific features of such transactions, refer Para 3 of the Chapter.
2. Hire Purchase is an agreement of hiring the asset whereas Instalment sale is an
agreement of sale. The title to goods passes on last payment in the hire purchase
transaction but the title to goods passes immediately in the case of instalment
sale. The hirer may return goods without further payment except for accrued
instalments in hire purchase transaction but in case of instalment sale, goods are
not returnable unless seller defaults. For details, refer Para 10 of the Chapter.
Practical Questions
Answer 1
STATEMENT SHOWING CASH VALUE OF THE MACHINE ACQUIRED ON HIRE-
PURCHASE BASIS
Instalment Interest @ 5% half yearly Principal Amount
Amount (10% p.a.) = 5/105 = 1/21) (in each instalment)
(in each instalment)
` ` `
5th Instalment 6,000 286 5,714
Less: Interest (286)
5,714
Add: 4th Instalment 6,000
11,714 558 5,442
Working Notes :
1. ` 2,00,000+ 2nd instalment of ` 2,20,000 = ` 4,20,000.
2. ` 3,81,818+ 1st instalment of ` 2,20,000 = ` 6,01,818.
Answer 3
(i) Calculation of Interest and Cash Price
No. of Outstanding Amount due Outstanding Interest Outstanding
installments balance at at the time of balance balance
the end after installment at the end at the
the payment before the beginning
of installment payment of
installment
[1] [2] [3] [4]= 2 +3 [5]= 4 x [6]= 4-5
10/110
3rd - 2,75,000 2,75,000 25,000 2,50,000
2nd 2,50,000 2,45,000 4,95,000 45,000 4,50,000
1st 4,50,000 2,65,000 7,15,000 65,000 6,50,000
Happy Account
Date Particulars ` Date Particulars `
1.10.X1 To Bank (down 5,00,000 1.10.X1 By Tractors a/c 11,50,000
payment)
30.9.X2 To Bank (1st 2,65,000 30.9.X2 By Interest a/c 65,000
Installment)
To Balance c/d 4,50,000
12,15,000 12,15,000
30.9.X3 To Bank (2nd 2,45,000 1.10.X2 By Balance b/d 4,50,000
Installment)
To Balance c/d 2,50,000 30.9.X3 By Interest a/c 45,000
4,95,000 4,95,000
30.9.X4 To Tractor a/c 1,97,225 1.10.X3 By Balance b/d 2,50,000
To Balance c/d (b.f.) 77,775 30.9.X4 By Interest a/c 25,000
2,75,000 2,75,000
31.12.X4 To Bank (Amount 81,275 1.10.X4 By Balance b/d 77,775
settled after 3 months) 31.12.X4 By Interest a/c 3,500
(@ 18% on bal.)
(77,775x3/12x18/100)
81,275 81,275