ACCOUNTANCY FORM 6 – HIRE PURCHASE ACCOUNTING

HIRE PURCHASE TRANSACTIONS.

As a system of trading, hire purchase is governed by the hire purchase act. Under this system the buyer agrees to pay for the goods by installments.

The property in goods remains with the seller and the buyer pays hire charges over a stipulated period of time at the end of which the pays a further amount called an option to purchase/ option fee which then gives him ownership. The buyer obtains possession for the goods and uses them, but ownership for the goods will pass from the seller to the buyer when the latter pays the final installment. If the buyer he fails to pay any installment, then seller will be entitled to take back the goods (repossess) and the buyer shall have no any claim over the installment he already paid.

ACCOUNTING PART

1. Buyers books.
   
2. Sellers books.
   

 

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Hire- purchase transactions in the buyers books

Goods which are dealt with are usually fixed assets such as motorcars, refrigerators and etc.

The hire purchase price actually it consists of two elements:-

1. Cash “cost” price and
   
2. Hire purchase interest.
   

 

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This acts as compensation to the seller for delay in receiving a full payment at once and also for covering up some attendant risks.

N.B

It is a normal accounting policy to treat hire purchase transactions as actual sales or purchase, because the intentions of the buyer 1st pay the whole amount through installments.

Methods of writing off the title purchase interest.

1. Straight line / fixed installment methods.
   
2. Sum of the digits method (or rule of 78 methods).
   
3. Actuarial method.
   

 

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This interest should be written off to P & L A/C over the period of the hire purchase contract.

1. Straight line method
   

 

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Under this method, the hire purchase interest written off on the straight line basis. Therefore the hire purchase interest per installment due =  (Total hire purchase /Interest)/(Total number of interest).                        

1. Some of the years’ digits method
   

 

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This is an arithmetical method of apportioning the hire purchase interest in approximate proportion to the amount outstanding at any time.

Procedure

1. Number the installments e.g. 3 installments
   

   1
   

   2
   

   3
   

2. Assign the highest digit to the first installment and digit one to the last installment
   

                                Installment                              digits
   

                                       1                                       3
   

                                       2                                       2
   

                                       3                                       1
   

3. Sum up the digits    6
   
4. Apportion the H.P. interest e.g I H.P interest   = Tshs 36000
   
   1. Apportion the H.P. interest e.g I H.P interest   = Tshs 36000
      

      1^st
      Year hire purchase interest     =3/6   x   36000
      

                                                       =   18000
      

      2^nd year hire purchase interest = 2/6 x 36000
      

                                                           =   12000
      

      3^rd year hire purchase interest   = 1/6 x 36000
      

    

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5.                                               =6000 
   

 

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Buyer’s books continue

1. Actuarial method
   

 

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This is method of the writing off the hire purchase interest based on the reducing balance phenomenon.

This method can be used in the presence of the following items:-

Cash price, deposit, (not necessary) rate of interest, number of installments together with their respective amounts.

Working:-

METHOD OF RECORDING.

There are two alternative methods of recording.

Method A

Accounting entries:                

 With the cash “cost price

         With the proportion of the H.P interest when  

                                                                 Installment is due

 With the deposit + installment paid

N.B

Balance on the vendor A/C represents the unpaid portion of the cash price, which should be included under current liabilities in the B/S.

METHOD B
1. Dr. Fixed assets A/C with the cash price
Dr H.P interest suspense A/C with the total H.P interest
Cr, vendors A/C with total H.P price.

with the proportion of the H.P interest  installment is due
                   

                   with the deposit   + installment paid

N.B

The balance on the vendor A/C less the balance of hires purchase interest suspense A/ shall be included current liabilities in the balance sheet.

Example

On 1^st Jan 1991, contractor’s ltd bought a hydraulic crane from Hi – lift ltd on hire purchase. The terms o f H.P contract were initial deposit of Tshs 40000 was payable followed by 3 installments of Tshs 37978 on 1^st Dec in each of the next three years from 1991 onwards. The cost of the crane for cash purchase would have Tshs. 120,000. Interest is charged on the balance out standing 31^st Dec at the rate of 20% p.a. the final year of both company’s end 31^st Dec.

Required

1. What was amount of H.P. Interest included in the H.P price?
   
2. What amount of interest could allocated in each of three years if the sum of digits method were used.
   
3. Prepare the relevant ledger a/c contraction ltd ledger for each of the three year ended 31^st Dec 1991, 1992, 1993 base on the assumption that contractors ltd charges depreciation on his fixed assets. Using a straight line method in addition 20% p.a interest rate is in uses.
   

 

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Solution

a) Hire purchase = Total H.P price – cash price

                             = Deposit + 3 installments – cash price

                             = (40000 + 3 x 37978) – 120,000

                             = Tshs.33934

1. Calculate of the H.P. interest by the sum of the digit method.
   

 

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Proportion of the H.P interest

1^st year; 3/6 x 33934 = 16967

2^nd year; 2/6 x 33934 = 11311

3^rd year; 1/6 x 33934 = 5656

     DR                       HI- LIFT COMPANY ACCOUNT                  CR

  DR     HIRE PURCHASE INTEREST EXPENSE ACCOUNT   CR

Example 2

A firm acquired two transport lames under hire purchase agreements, details of which are as follows:

Registration number                                    KQ710                                               KU600

Date of purchase                              30^TH May 1998                                 30^th October 1998

Cash price                                         540000                                               720000

Deposit                                              93600                                                144000.

Interest (deemed to accrue)

Every over the period of the

Agreement)                                       76800                                                  96000

Both agreements provided for the payment to be made in twenty four equal monthly installments commencing on the last day of the mount following purchase.

On 1^st July 1999 vehicle KQ710 become a total loss in full settlement on 10^th July 1999.

1. An insurance company paid Tshs 42000 under a comprehensive policy and
   
2. The hire purchase company accepted Tshs 190000 for the termination of the agreement.
   

   The firm prepared the accounts annually to 31^st December, and provided depreciation on a straight line basis at a rate of 25% per annum for motor vehicle. With a full year depreciation in the year of purchase no depreciation being provided in the year of disposal.
   

   All installments were paid on the due dates.
   

 

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Required:

Record these transactions in the following accounts, carrying down the balance as on 31 Dec 1999.

1. Motor vehicles
   
2. Provision for depreciation
   
3. Motor vehicles disposal
   
4. Hire purchase company
   
5. Hire purchase interest suspense A/C
   

 

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DR                               MOTOR VEHICLE ACCOUNT                            CR

Total installment paid for 1998 for

                             152,600 +   56,000   =   208,600

   DR                            HIRE PURCHASE COMPANY ACCOUNT    CR

 DR    HIRE   PURCHASE   INTEREST SUSPENSE ACCOUNT   CR

 DR M. VEHICLE ACCOUNT PROV.FOR DEPREC. ACCOUNT  CR

   DR                     MOTOR VEHICLE DISPOSAL ACCOUNT          CR

Total installment paid up to 1/7/1999

For ( KQ)   = 6 X 21800

                   = 130,800

For (KV) = 28000 X 12 = 336,000
24-(6+7)=11 Months

Installment due = 11 x 21800

                         = 239800

                       = 239800 – 190,000

                         = 49800

3. J. York was acquiring two cars under hire purchase agreements details of which are as follows.

Registration number                                                JY 1                                      JY2

Date of purchase                                                 31 June 20 x 6                        30 Nov 20 x6

Cash price                                                            £ 18,000                                  £ 24,000

Deposit                                                                 £ 3120                                      £ 4800

Interest (deemed to accrue every

Over the period of the agreement)                     £ 1920                                       £ 2400

Both agreements provided for payment to be made in 24 monthly installment commencing on the last day of the month following purchase.

On 1 September 20 x 7, vehicle Jy 1 becomes a total loss. In full settlement on

30 September 20 x7

1. An insurance co. paid 12500 under a comprehensive policy.
   
2. The hire purchase company accepted 6000 for the termination of the agreement.
   

   The firm prepared accounts annually to 31 Dec and provided depreciation on a straight line basis at a rate of 20 percent per Annam for motor, apportioned as from the date of purchase and up to the date of disposal.
   

 

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All installments were paid on due dates

The balance on the hire purchase company account in respect of vehicle Jy 1 is to be written off

You are required to record these transactions in the following accounts, carrying down the balance as on 31 Dec 20 x 2

1. Motor vehicle
   
2. Depreciation
   
3. Hire purchase company
   
4. Assets disposal
   

 

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DR                   MOTOR VEHICLE ACCOUNT                                   CR

Total installment paid for 2006 (4200 + 900) = 5100

JY1 30/6/2006 – 31/12/2006                   JY2   31.11.2006   –   31.12.2006

6 x 700 = 4200                                                 900 x 1 = 900

Total installment paid up 1/9/2007

JY1 = 700 x 8 = 5600

JY2 = 900 x 12= 10800

Installment due = 24 – (6+8) = 10

                           = 700 x 10 = 7000

                           = 7000 – 6000

                           = 1000
DR MOTOR VEHICLE DEPRECIATION ACCOUNT    CR

   DR                                 DISPOSAL ACCOUNT                             CR

 DR    HIRE PURCHASE INTEREST SUSPENSE ACCOUNT      CR

Interest payable (Total)                                       JY1 P& L

JY1 = 80x 6 =   480                                             31/6 – 31/12 = 6 months

JY2 = 100 x 1 = 100                                               24 – 6 = 18

                       580                                               18 x 80 = 1440

IN SELLER’S BOOKS

Goods can be categorized into two major categories

1. Large items
   
2. Small items
   

 

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Large items

These are the one which business buyers treat as fixed assets. In this case the amounts involved are substantial and transactions are relatively infrequent. Therefore the supplier is able to identify transactions surrounding each class of goods under hire purchase will ease. That is, the supplier can spread the gross profit and hire purchase interest over the hire purchase contract without much difficulty.

The hire purchase selling is made up of the following elements;

• Cost price plus gross profit giving the cash selling price.
  
• Cash selling price plus the hire purchase interest giving hire purchase selling price.
  
• H.P selling price   =   cost price + gross profit   +   hire purchase interest.