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Wednesday, March 28, 2012

Hire Purchase and Installment Purchase System

Hire Purchase - Meaning:
A trader could sell goods either for cash or for credit. For goods sold on credit, the payments may be made by the buyer in lump sum on a future date, or in installments spread over for a specified period of time. When goods are sold on credit, for which payment is made by the buyer in installments over a period of time, it is called purchase system or installment system.
Hire Purchase System defers to the system wherein, the seller of goods delivers the goods to the buyer without transferring the ownership of goods. The payment for the goods will be made by the buyer in installments. If the buyer pays all the installments, the ownership of the goods will be transferred, on payment of the last installment. However, if the buyer does not pay for any installment, the goods will be repossessed by the seller and the money paid on earlier installments will be treated as hire charges for using the goods. So, under this system, the transaction may result in purchasing of goods by the buyer or in hiring the goods. Hence, the system is called Hire Purchase System.
Characteristics of Hire-Purchase System
The characteristics of hire-purchase system are as under
a)      Hire-purchase is a credit purchase.
b)      The price under hire-purchase system is paid in installments.
c)       The goods are delivered in the possession of the purchaser at the time of commencement of the agreement.
d)      Hire vendor continues to be the owner of the goods till the payment of last installment.
e)      The hire-purchaser has a right to use the goods as a bailer.
f)       The hire-purchaser has a right to terminate the agreement at any time in the capacity of a hirer.
g)      The hire-purchaser becomes the owner of the goods after the payment of all installments as per the agreement.
h)      If there is a default in the payment of any installment, the hire vendor will take away the goods from the possession of the purchaser without refunding him any amount.
Difference Between Sale and Hire Purchase
Although hire purchase system could ultimately result in sale of goods, the sale in normal sense and sale under hire purchase system are not the same. The following are the differences between sale and hire purchase.
Sale
Hire Purchase
A ‘sale’ is governed by the sale of Goods Act, 1930.
Hire purchase is governed by the Hire Purchase Act, 1972.
In case of sale, the ownership of the goods is transferred to the buyer immediately.
In case of Hire purchase, the ownership of goods is transferred to buyer on payment of all installments.
In case of sale, the buyer makes payment in lump sum.
In case of hire purchase, the payment is made in installments.
The buyer pays only for the price of goods.
The hire purchaser pays for the price of goods and also some amount of interest.
On non-payment of the consideration the seller cannot take back the goods, but can only take legal action on buyer.
On non-payment of any installment, the seller can re-possess the goods.
Once a sale has taken place, neither the seller, nor the buyer can terminate the contract (unless it is for genuine reason like damage of goods etc.)
Either the buyer or the seller can terminate the contract at any point of time, until the payments of last installment.
When the buyer becomes insolvent, the seller has to undertake the risk of loss.
When the hire purchaser becomes insolvent, the seller can reposes the goods, and hence need not undertake the risk of loss.
A sale is subject to levy of sales tax at the time of contract of sale.
In this case, the sales tax will be leviable at the time of ownership (i.e. on payment of last installment).


Difference Between Agreement to Sale and Hire Purchase
Although hire purchase system could ultimately result in sale of goods, the agreement to sale in normal sense and sale under hire purchase system are not the same. The following are the differences between sale and hire purchase.
Agreement to Sale
Hire Purchase
A ‘sale’ is governed by the sale of Goods Act, 1930.
Hire purchase is governed by the Hire Purchase Act, 1972.
Contract of Sale includes both sale ang agreement ot sale.
Hire purchase is bailment plus agreement ot Sale.
Agreement to sale is a step, to the contract of sale.
Hire purchase agreement becomes a sale only after full payment.
In an agreement to sale, the buyer can sell or pledge the goods.
In Hire purchase, the buyer cannot sell or pledge the goods.
The buyer pays only for the price of goods.
The hire purchaser pays for the price of goods and also some amount of interest.

Accounting treatment in the books of hire purchaser
There are three methods to maintain the accounts in the books of hire purchaser they are.
A. Outright property method: under this method the asset is recorded at full cash price.
B. Asset accrual method: under this method the asset is recorded at the cash price actually paid (asset accrued is recorded)
C. Interest suspense method: under this method the total interest is first debited to interest suspense account at the beginning subsequently the interest due at the end of the period is credited to interest suspense account.

JOURNAL ENTRIES IN THE BOOKS OF HIRE-PURCHASER
Sl. No.
Circumstances
Outright property
Asset accrual
Interest suspense
          At the time of asset purchased.
01
When the asset is purchased
Asset a/c Dr
  To hire vendor a/c
No entry
Asset a/c Dr
Interest suspense a/c Dr
  To vendor a/c
02
When the down payment is made
Hire vendor a/c Dr
  To bank a/c
Asset a/c Dr
  To bank a/c
Vendors a/c Dr
  To bank a/c
          At the end of every year.
03
When the installment interest becomes due
Interest a/c Dr
To hire vendor a/c
Asset a/c Dr
Interest a/c Dr
  To hire vendor a/c
Interest a/c Dr
  To interest suspense a/c
04
When the installment is paid
Hire vendor a/c Dr
To bank a/c
Hire vendor a/c Dr
To bank a/c
Vendors a/c Dr
  To bank a/c
05
When the depreciation is charged
Depreciation a/c Dr
  To asset a/c
Depreciation a/c Dr
  To asset a/c
Depreciation a/c Dr
  To asset a/c
06
When the depreciation and interest is transferred to p/l a/c
Profit / loss a/c Dr
  To interest a/c 
  To depreciation a/c
Profit / loss a/c Dr
  To interest a/c 
  To depreciation a/c
Profit / loss a/c Dr
  To interest a/c 
  To depreciation a/c

JOURNAL ENTRIES IN THE BOOKS OF HIRE-VENDOR 
Sl. No.
Circumstances
Outright property
Asset accrual
Interest suspense
          At the time of asset purchased.
01
When the asset is sold
 Hire-purchaser a/c Dr
  To sales a/c 
No entry
 Purchaser a/c Dr
  To sales a/c
  To interest suspense a/c
02
When the down payment is received 
  Bank a/c Dr
  To hire-purchaser a/c 
Asset a/c Dr
  To bank a/c
Bank a/c Dr
  To purchaser a/c    
          At the end of every year.
03
When the installment interest becomes due
Hire-purchaser a/c Dr
  To Interest a/c 
Asset a/c Dr
Interest a/c Dr
  To hire vendor a/c
interest suspense a/c Dr
  To Interest a/c
04
When the installment is received
 Bank a/c Dr
  To hire-purchaser a/c 
Hire vendor a/c Dr
To bank a/c
 Bank a/c Dr
  To purchaser a/c 
05
When the interest is transferred to p/l a/c
Interest a/c  Dr
  To Profit / loss a/c   
 
Profit / loss a/c Dr
  To interest a/c 
  To depreciation a/c
 
Interest a/c  Dr
  To Profit / loss a/c   
 



Ascertainment of interest: -
1. When rate of interest is given: - Cash price less down payment add interest less installment 
2. When rate of interest is not given: - Ascertain total amount of interest (total amount- cash price) and then ascertain the interest installment with the help of ratio of amount due at the beginning of each year.
Amount due at the beginning of 1st year = total amount- down payment
Amount due at the beginning of 2nd year = first year due – 1st installment
Amount due at the beginning of 3rd year = second year due – 2nd installment

Ascertainment of total cash price: -    
1. Without the help of annuity table  
2. with the help of annuity table 
1. without the help of annuity table: - Total cash price = cash price installment + down payment
Cash price installment is calculated by deducting the interest installment from the installment amount starting with last installment. The interest installment is calculated with the help of following formula:
Interest= total amount due at the time of installment X   (rate of interest /100+rate of interest)    
2. with the help of annuity table: - under this method the cash price is ascertained with the help of annuity value.
Cash price installment = installment X annuity value
Total cash price = cash price installment + down payment  

Important terms and provisions
1. Hire purchaser: A hire purchaser is a person who possesses the goods under hire purchase agreement for use within an option to either purchase it or return after use.
2. Hire vendor: a hire vendor is a person who sells the goods under hire purchase agreement.
3. Cash price: it is the price of goods which is sold under ‘contract of sale’
4. Hire purchase price: it is the price at which the goods are sold under ‘hire purchase system’ it includes cash price of the goods and interest.
5. Installment money: it is the part of the hire purchase price paid by hire purchaser, in periodic intervals.
6. Deposit: it refers any sum payable by the hirer under the hire purchase agreement by way of initial payment or credited or to be credited to him under the agreement on account of any deposit.
7. Net cash price: it refers to the difference between cash price of the goods and deposit (cash price-down payment=net cash price).
8. Net hire purchase price: it is the net amount after deducting the delivery charges, registration charges, insurance charges from hire purchase price.
9. Hire charges: it is an amount refers to the difference between hire purchase price and cash price (H P- C P= H C) it also referred to as interest.
10. Statutory hire charges: it is a hire charges according to the hire purchase act of, 1972.
11. Hire purchase agreement: it is an agreement between hire purchaser and hire vendor according to section 2(c) of the hire purchase act, 1972 for purchasing of goods according to agreement.
12. Rebate: it is an amount which is claimed by the hire purchaser from the hire vendor in case if he decides to remit the balance of the purchase price (future installments) in lumsum without continuing the hire purchasing agreement.
The rebate is calculated as follows
Rebate = 2/3 X hire charges X (no. of installments due/total no. of installments)
13. Termination of hire purchase agreement: The hirer can terminate the agreement at any time by giving the 14 days notice to the owner. However what ever the amount is already paid by the hirer is considered as a hire charges.

INSTALMENT PURCHASE SYSTEM
Meaning:
Installment payment system (also called the deferred installments) is a system where the buyer is given the ownership as well as the possession of the gods at the time of signing the contract. The buyer has the facility to pay the price in installments.
Definition:
According to J.B. Batliboi, Installment Purchase System is a system under there is an agreement to purchase and pay by installments, the goods which become the property of the Purchaser immediately when he receives the delivery of the same.
Features of Installment Payment System:
The features of Installment payment are as follows:
a)      Under this system, there will be an outright sale of goods/assets.
b)      The possession as well as the ownership is passed to the buyer right at the time of signing the contract.
c)       The buyer can make the payment in installments.
d)      IN case of default in payment, the seller cannot repossess the goods, but he can sue the buyer for the recovery of unpaid price.
e)      The buyer cannot exercise the option of returning the goods and terminate the contract, unless the same becomes void or voidable under the contract act.
Differences Between Hire Purchase System and Installment Purchase System:
Hire-Purchase System
Installment Purchase
It is a contract of hiring.
It is a contract of sale.
It is transferred by seller to buyer only after payment of all installments.
It is transferred by seller to buyer, immediately on signing the contract.
In this case, the buyer is like a bailee
In this case, the buyer is not in the position of a bailee
Such risk is on the seller.
Such risk is on the buyer.
On default of payment of any installment by the buyer, the seller can repossess the goods.
On default and payment of any installment by the buyer, seller cannot repossess the goods, but can file a suit in the court of law against the buyer for the recovery of unpaid price.
The buyer can exercise the option of return of goods.
The buyer cannot exercise the option of return of goods.
The buyer cannot dispose the goods, until the payment of last installment. If disposed, the third party buyer does not get a better title.
The buyer has the right to dispose the goods, even if all installments are not yet paid.