Meaning of Hire Purchase System

The Hire Purchase System is a special method of buying and selling goods in which the purchaser receives the goods at the start of the agreement but doesn’t gain ownership until all installments are paid. The seller allows the buyer to pay for the goods in installments, and if all payments are made, ownership is transferred. However, if the buyer misses payments, the seller can repossess the goods, and the money paid up to that point is considered as hire charges for using the goods. This system allows for either purchasing or hiring goods, hence the name “Hire Purchase System.”

Characteristics of Hire Purchase System

The hire-purchase system has following characteristics:

It functions as a method of credit sale.
The total price of the goods is paid through installments.
The purchaser receives possession of the goods at the beginning of the agreement.
The vendor remains the legal owner of the goods until the final installment is paid.
The hire purchaser is granted the right to use the goods as a bailer.
The hire purchaser can terminate the agreement at any time in the capacity of a hirer.
Ownership of the goods is transferred to the hire purchaser after completing all installments as per the agreement.
In case of any installment default, the hire vendor can repossess the goods without refunding any amount to the purchaser.

Terms used in Hire Purchase System

In the agreement of hire purchase, the following terms are used:

Hire Vendor: Refers to the seller who sells the goods on a hire basis as per the hire purchase agreement.
Hire Purchaser: Refers to the buyer who acquires the goods on a hire basis through the hire purchase agreement.
Down Payment: The initial payment made by the hire purchaser at the time of signing the hire purchase agreement.
Cash Price: The total amount required to purchase the goods or asset, excluding any interest charges.
Hire Purchase Price: The total amount to be paid if the goods are to be purchased under the hire purchase system. This price includes the cash price of the goods as well as the interest on future installments.
Installment: Hire purchase price of goods or asset is paid in several installments. Each installment may include interest or not. After paying all instalment the hire-purchaser, becomes the owner of the asset.

Accounting Records in the books of Hire Purchaser

There are two methods used for accounting records in the books of Hire Purchaser

Asset Accrual Method

Under this method, the hire purchaser is regarded as the owner of the asset up to the value of the cash price paid by them, either through the down payment or the cash price included in the different installments.
Hire Purchaser thinks that they become the owner of the asset.
Firstly down payment made then cash price of the installment and interest become due and paid.

Credit Purchase Method

Hire Purchaser treats hire purchase as real purchase.
Firstly full cash price of the asset become due then down payment made.
Afterwards interest of the installment becomes due and after it installment paid.

Journal Entries in the books of Hire Purchaser

(Asset Accrual Method)

Date	Particulars	L.F.	Dr. Amount	Cr. Amount
	When down payment becomes due
	Asset A/c Dr.		—
	To Hire Vendor’s A/c			—
	(Being down payment due)

	When down payment is paid
	Hire Vendor’s A/c Dr.		—
	To Cash or Bank A/c			—
	(Being down payment paid)

	When the Installment becomes due
	Asset A/c (Cash Price of the asset in the installment) Dr.		—
	Interest A/c (Interest of the asset in the installment) Dr.		—
	To Hire Vendor’s A/c (Total Installment)			—
	(Being installment due)

	When Installment paid
	Hire Vendor’s A/c (Total installment) Dr.		—
	To Cash or Bank A/c			—
	(Being installment paid)

	When depreciation is charged
	Depreciation A/c (Calculated on Cash Price) Dr.		—
	To Asset A/c			—
	(Being depreciation charged)

	For transfer of Interest & Depreciation
	Profit and Loss A/c Dr.		—
	To Interest A/c (Interest of the asset in the installment)			—
	To Depreciation A/c (Depreciation Charged)			—
	(Being interest and depreciation transfer to profit and loss a/c)

*Red Text is for understanding which will help you to solve the numerical.

#last four journal entries will be repeatedly used on every installment or based on numerical.

Journal Entries in the books of Hire Purchaser

(Credit Purchase Method)

Date	Particulars	L.F.	Dr. Amount	Cr. Amount
	At the time of Hire Purchase Agreement
	Asset A/c (Total Cash Price of the asset) Dr.		—
	To Hire Vendor’s A/c			—
	(Being asset purchased on hire-purchase system)

	When down payment is paid
	Hire Vendor’s A/c Dr.		—
	To Cash or Bank A/c			—
	(Being down payment paid)

	When the Installment becomes due
	Interest A/c (Interest of the asset in the installment) Dr.		—
	To Hire Vendor’s A/c			—
	(Being installment paid)

	When Installment paid
	Hire Vendor’s A/c (Total installment) Dr.		—
	To Cash or Bank A/c			—
	(Being installment paid)

	When depreciation is charged
	Depreciation A/c (Calculated on Cash Price) Dr.		—
	To Asset A/c			—
	(Being depreciation charged)

	For transfer of Interest & Depreciation
	Profit and Loss A/c Dr.		—
	To Interest A/c (Interest of the asset in the installment)			—
	To Depreciation A/c (Depreciation Charged)			—
	(Being interest and depreciation transfer to profit and loss a/c)

*Red Text is for understanding which will help you to solve the numerical.

#last four journal entries will be repeatedly used on every installment or based on numerical.

Journal Entries in the books of Hire Vendor

Date	Particulars	L.F.	Dr. Amount	Cr. Amount
	When goods are sold under Hire Purchase
	Hire Purchaser’s A/c Dr.		—
	To Sales A/c			—
	(Being goods sold)

	When down payment is received
	Cash or Bank A/c Dr.		—
	To Hire Purchaser’s A/c			—
	(Being down payment received)

	When the interest of the installment becomes due
	Hire Purchaser’s A/c Dr.		—
	To Interest A/c (Interest of the asset in the installment)			—
	(Being interest of the installment due)

	When Installment is received
	Cash or Bank A/c (Total installment) Dr.		—
	To Hire Purchaser’s A/c			—
	(Being installment amount received)

	For transfer of Interest
	Interest A/c (Interest of the asset in the installment) Dr.		—
	To Profit and Loss A/c			—
	(Being interest transfer to profit and loss a/c)

*Red Text is for understanding which will help you to solve the numerical.

#last three journal entries will be repeatedly used on every installment or based on numerical.

Necessary Accounts

In the books of Hire Purchaser	In the books of Hire Vendor
Assets Account	Hire Purchaser’s Account
Hire Vendor’s Account	Interest Account
Interest Account
Depreciation Account

Scenarios of Questions

	Installment	Rate of Interest	Cash Price
I	Given	Given	Given
II	Given	Given	Not Given
III	Given	Not Given	Given

Other Scenarios

When interest is included in the installment	When interest is not included in the installment
When the down payment and all the installments total is exceeds then the cash price	When the down payment and all the installments total is equal to the cash price.
Example:	Example:
Cash Price: ₹ 1,00,000	Cash Price: ₹ 1,00,000
Down Payment: ₹ 25,000	Down Payment: ₹ 20,000
Four Installment ₹ 25,000 each : Total 1,00,000	Four Installment ₹ 20,000 each : Total 80,000
Here the total is ₹ 1,25,000 which is exceeds then Cash Price	Here the total is ₹ 1,00,000 which is equal to Cash Price
₹ 1,25,000 (Total Amount) — ₹ 1,00,000 (Cash Price) = ₹ 25,000 (Interest)	₹ 1,00,000 (Total Amount) = ₹ 1,00,000 (Cash Price)

Analysis Table for Calculation of Interest and Cash Price

Date and Year	Cash Price Balances after each installment	Cash Price	Interest	Total Amount (Hire Purchase Price)




Total	Nil	—	—	—

Practical Question

A purchased car from Y Ltd. on a Hire-Purchase Agreement on 1st April, 2018, paying cash 1,00,000 agreeing to pay three further instalments of 1,00,000 each on 31st March of every year. The cash price of the car is 3,72,500 and Y Ltd. charges interest at 5% per annum. The purchaser write off 10% depreciation every year on the cash value of the car on the reducing balance method. Make the necessary accounting records in Journal of both the parties.

Down Payment + Four Installments = Total Price

₹1,00,000 + ₹3,00,000 = ₹4,00,000

Total Price – Cash Price = Interest

₹4,00,000 – ₹3,72,500 = ₹27,500

According to Question interest is included in the installments.

Date and Year	Cash Price Balances after each installment	Cash Price	Interest	Total Amount (Hire Purchase Price)
2018	372,000	—	—	—
Apr-01	– 100,000			100,000
2019	272,500
March-31	– 86,375	86,375	13,625	100,000
2020	186,125
March-31	– 90,694	90,694	9,306	100,000
2021	95,431
March-31	–95,431	95,431	4,569	100,000
Total	Nil	3,72,500	27,500	4,00,000

Working Note:

Interest on 2019:

2,72,500 × 5% = 13,625

Interest on 2020:

1,86,125 × 5% = 9,306

Interest on 2021:

1,00,000 – 95,431 = 4,569

Journal Entries in the books of Mr. A (Hire Purchaser)

(Asset Accrual Method)

Date	Particulars	L.F.	Dr. Amount	Cr. Amount
	Car A/c Dr.		100,000
	To Y Ltd. A/c			100,000
	(Being down payment due)
	Y Ltd. A/c Dr.		100,000
	To Cash A/c			100,000
	(Being down payment paid)
	Car A/c Dr.		86,375
	Interest A/c Dr.		13,625
	To Y Ltd. A/c			100,000
	(Being installment paid)
	Y Ltd. A/c Dr.		100,000
	To Cash A/c			100,000
	(Being installment paid)
	Depreciation A/c Dr.		37,250¹
	To Car A/c			37,250
	(Being depreciation charged)
	Profit and Loss A/c Dr.		50,875
	To Interest A/c			13,625
	To Depreciation A/c			37,250
	(Being interest and depreciation transfer to profit and loss a/c)
	Car A/c Dr.		90,694
	Interest A/c Dr.		9,306
	To Y Ltd. A/c			100,000
	(Being installment paid)
	Y Ltd. A/c Dr.		100,000
	To Cash A/c			100,000
	(Being installment paid)
	Depreciation A/c Dr.		33,525²
	To Car A/c			33,525
	(Being depreciation charged)
	Profit and Loss A/c Dr.		42,831
	To Interest A/c			9,306
	To Depreciation A/c			33,525
	(Being interest and depreciation transfer to profit and loss a/c)
	Car A/c Dr.		95,431
	Interest A/c Dr.		4,569
	To Y Ltd. A/c			100,000
	(Being installment paid)
	Y Ltd. A/c Dr.		100,000
	To Cash A/c			100,000
	(Being installment paid)
	Depreciation A/c Dr.		30,172.50³
	To Car A/c			30,172.50
	(Being depreciation charged)
	Profit and Loss A/c Dr.		34,741.50
	To Interest A/c			4,569
	To Depreciation A/c			30,172.50
	(Being interest and depreciation transfer to profit and loss a/c)

Calculation of Depreciation

¹ 2019 3,72,500 × 10% = 37,250

Dep.– 37,250

² 2020 3,35,250 × 10% = 33,525

Dep. – 33,525

³ 2021 3,01,725 × 10% = 30,172.50

Dep. – 30,172.50

Written Down Value 2,71,552.50