Hire-puchase system is a special system of purchase and sale of goods. Under this system purchaser pays the price of the goods in instalments. The instalments may be annual, six monthly, quarterly, monthly fortnightly etc. Under this system the goods are delivered to the purchaser at the time of agreement before the payment of instalments but the title on the goods is transferred after the payment of all instalments as per the hire-purchase agreement. The special feature of a hire-purchase transaction is that the payment of every instalment is treated as the payment of hire charges by the purchaser to the hire vendor till the payment of the last instalment.. After the payment of the last instalment, the amount of various instalments paid is appropriated towards the payment of the price of the goods sold and the ownership or the goods is transferred to the purchaser. Thus hire-purchase means a transaction where the goods are sold by vendor to the purchaser under the following conditions :

the goods will be delivered to the purchaser at the time of agreement.
the purchaser has a right to use the goods delivered.
the price of the goods will be paid in instalments.
every instalment will be treated to be the hire charges of the goods which is being used by the purchaser.
if all instalments are paid as per the terms of agreement , the title of the goods is transferred by vendor to the purchaser.
if there is a default in the payment of any of the instalments, the vendor will take away the goods from the possession of the purchaser without refunding him any amount received earlier in the form of various instalments.
Before discussing the characteristics of hire-purchase system, we must know what is a hire purchase agreement and what are the contents of a hire-purchase agreement. Hire-purchase agreement means a contract between the hire vendor and the hire purchaser regarding the sale of goods under certain conditions. Usually every hire-purchase agreement shall contain the following terms:

the cash price of the goods, cash price means the price at which goods may be purchased against cash payment.
the hire-purchase price, hire purchase price means the total amount which is payable by the hire-purchaser under the agreement.
the date on which the hire-purchase agreement will commence.
the description of the goods that will be delivered to the hire-purchaser at the commencement of the agreement.
the number of instalments to be paid by the hire-purchaser along with the amount of each instalment and the date of payment of each instalment.
the down payment if any, the down payment means the amount which is required to be paid by hire-purchaser to the hire vendor at the time of commencement of hire-purchase agreement.
the rate interest charged by the hire vendor (optional).

Characteristics of Hire-Purchase System
The characteristics of hire-purchase system are as under

Hire-purchase is a credit purchase.
The price under hire-purchase system is paid in instalments.
The goods are delivered in the possession of the purchaser at the time of commencement of the agreement.
Hire vendor continues to be the owner of the goods till the payment of last instalment.
The hire-purchaser has a right to use the goods as a bailer.
The hire-purchaser has a right to terminate the agreement at any time in the capacity of a hirer.
The hire-purchaser becomes the owner of the goods after the payment of all instalments as per the agreement.
If there is a default in the payment of any instalment, the hire vendor will take away the goods from the possession of the purchaser without refunding him any amount.

Difference between Hire-purchase system and Instalment payment system

Instalment Payment System is system of purchase and sale of goods in which title of goods is immediately transferred to the purchaser at the time of sale of goods and the sale price of the goods is paid in instalments. In the event of default in payment of any instalment, the seller has no right to take back goods from the possession of the purchaser. He can file a suit for the recovery of the outstanding balance of the price of goods sold. The followings are the differences between Hire-purchase system and Instalment payment system:

In Hire-purchase system, the transfer of ownership takes place after the payment of all instalments while in case of Instalment payment system, the ownership is transferred immediately at the time of agreement.
In Hire-purchase system, the hire-purchase agreement is like a contract of hire though later on it may become a purchase after the payment of last instalment while in Instalment payment system, the agreement is like a contract of credit purchase.
In case of default in payment , in Hire-purchase system the vendor has a right to back goods from the possession of the hire-purchaser while in case of Instalment payment system, the vendor has no right to take back the goods from the possession of the purchaser; he can simply sue for the balance due.
In Hire-purchase system, if the purchaser sells the goods to a third party before the payment of last instalment, the third party does not get a better title on the goods purchased. But in case of Instalment payment system, the third party gets a better title on the goods purchased.
In Hire-purchase system the provisions of the Hire-purchase Act apply to the transaction while in case of Instalment payment system, the provisions of Sale of Goods Act apply to the transaction.
1.6 Accounting In the books of Hire-purchaser

There are two methods of accounting in the books of Hire-purchaser. Their detailed description is as under:-

Asset Accrual Method:
Under this method it is considered that the hire-purchaser is the owner of the asset up to the value of the cash price paid by him in the from of down payment or the cash price paid included in various instalments. The following journal entries are recorded under this method.

(i)On taking the delivery of asset:

No entry is recorded.

(ii)On making the down payment (if any)

Asset A/c Dr. (Amount of down payment)

To Cash/Bank A/c.

(iii)On becoming the instalment due

Asset a/c. Dr (Balancing figure)

Intt. A/c. Dr. (Amt. of Intt.)

To Hire-Vendor A/c. (Amt. of Instalment)

(iv)On payment of instalment:

Hire-Vendor A/c Dr. (Amt. of Instalment)

To Cash/Bank A/c.

(v)On charging the Depreciation:

Depreciation A/c Dr. (Amt. of Depreciation)

To Asset A/c.

(vi)On Transfer of interest and depreciation to P/L A/c:

P/L A/c. (Total amt.)

To Interest A/c (Bal. of Intt. A/c.)

To Depreciation A/c. (Bal. of Dep. A/c.)

Under Total Assets Value Method:
Under this method of accounting in the books of hire-purchaser, is done on the assumption that the ownership of the asset is also transferred to the purchaser with the delivery of goods. The following journal entries are recorded under this method.

(i)On taking the delivery of assets at the time of agreement:

Asset A/c Dr. (Cash price of Asset)

To Hire vendor A/c.

(ii)On making the down-payment (if any):

Hire-Vendor....... A/c. Dr. (Amount of down payment)

To Cash/Bank A/c

(iii)On becoming the instalment due:

Interest A/c. Dr. (Amount of interest)

To Hire-Vendor A/c

(iv)On payment of instalment:

Hire-Vendor a/c Dr. (Amount of instalment)

To Cash/Bank A/c

(v)On charging the depreciations:

Depreciation A/c. Dr. (Amount of depreciation)

To Asset A/c.

(vi)On Transfer of interest and depreciation to P/L A/c:

P/L A/c. Dr. (Total)

To Interest A/c. (Bal. of Intt. A/c.)

To Depreciation A/c. (Bal. of Dep. A/c.)


Posting in Ledger Accounts: After passing journal entries under any of the methods discussed above, the following ledger accounts are opened in the ledger and the postings are made accordingly.

(i) Asset A/c. (e.g. Trucks A/c, Machinery A/c. etc.)
(ii) Vendor's A/c.
(iii) Interest A/c.
(iv) Depreciation A/c.

Note: Before recording the entries the amounts of interest and depreciation will be calculated in two separate tables showing the calculations of interest and depreciation.

Calculation of Interest

The total payment made under hire-purchase system is more than cash price. In fact, this excess of payment over the cash price is interest. It is very essential to calculate interest because the amount paid for interest is charged to revenue and the asset is capitalized at cash price. Thus normally all instalments will include a part of cash price and a part of interest on the outstanding balance. However the amount paid at the time of agreement (down payment) will not include any interest. The calculation of interest is made under two conditions:

(a) When interest is included in amount of instalment: Where the hire-purchase price i.e. payment made in the form of down payment and all instalments is more than the cash price, it is regarded that the interest is included in instalments. It is explained in the following example.

Worked out Example-1 (Calculation of Interest)
On Ist April,2005 Mr. X purchased from M/s Y & Co. one 'Motor Truck' under hire-purchase system, Rs. 5,000 being paid on delivery and the balance in five annual instalments of Rs. 7,500 each payable on 31st March each year. The cash price of the motor truck is Rs. 37,500 and vendors charge interest at the rate of 5 per cent per annum on yearly balances. Find out the amounts of principal and interest included in each instalment.


(b) When interest is not included in instalments: Where the total amount paid in the form of down payment and all instalments is exactly equal to the cash price, it is regarded that the interest is not included in instalments. It means that interest is payable in addition to the agreed amount of instalment. It is explained in the following example.

Workedout Example-2 (Calculation of Interest): On April 1,2005, A Transport Company purchased a Motor Lorry from Motor Supply Co. Ltd. on hire-purchase basis, the cash price being Rs. 60,000. Rs. 15,000 on signing of the contract and balance in three annual instalments of Rs. 15,000 each on 31st March every year. In addition to it, interest at 5 per cent per annum was also payable to vendors on outstanding balances.