You know, there are two parties to a hire purchase agreement i.e., the Vendor and the Purchaser. Both these parties have to maintain books of account and record all the transactions relating to that particular hire purchase. Before explaining the accounting records, let us first see what information is required for recording the hire purchase transaction in the books of account. The list of items required for accounting records is as follows:
1. Date of Purchase and down payment
2. Date at which the instalments become due
3. Date of closure of accounts
4. Cash Price
5. Hire Purchase Price
6. Number, Amount and Mode of each instalment
7. Rate of Interest
8. Rate of Depreciation
9. Method of Depreciation
Let us now see how accounting records are maintained in the books of the purchaser. There are two methods by which the purchaser can record the hire purchaser transaction in the books of account. These are as follows:
i) When the asset is recorded at the full cash price, and
ii) When the asset is recorded at the cash price actually paid.
Let us now discuss these methods in detail.
When the Asset is Recorded at Full Cash Price
In this method, when the asset is purchased on hire purchase, it is assumed that the purchaser has full intention of paying all the instalments. It is believed that hire purchase is just a method of financing fixed assets. Under this method, on purchase of plant and machinery, the Plant & Machinery Account (Fixed Asset) is debited with the total amount of Cash Price, and the corresponding credit is given to Hire Vendor’s Account. Interest is recognised and accounted for at the time of instalments becomes due by debiting the Interest Account and crediting the Hire Vendor’s Account. For the purpose of accounting for initial cash down payment and annual instalments, the Hire Vendor’s A/c is debited on the relevant date, and the credit is given to Bank Account. The following journal entries are passed in the books of the purchaser.
1 When the asset is purchased on hire purchase
Asset A/c Dr.
To Hire Vendor A/c
(With the total cash price)
2 For cash down payment
Hire Vendor A/c Dr.
To Bank A/c
3 When the first instalment becomes due
Interest A/c Dr.
To Hire Vendor A/c
4 When the first instalment is paid
Hire Vendor A/c Dr.
To Bank A/c
5 For Depreciation Charge (at the end of accounting period)
Depreciation A/c Dr.
To Asset A/c
6 For transfer of interest and depreciation to Profit & Loss A/c
Profit& Loss A/c Dr.
To Interest A/c
To Depreciation A/c
Entries 3 and 4 will be repeated for all subsequent instalments. With the help of the journal entries, we can easily prepare the Asset Account and the Hire Vendor’s Account.
When the Asset is Recorded at Cash Price Actually Paid
You know that in case of hire purchase, the ownership of the goods passes to the hire purchaser after the last instalment has been paid. Since the goods do not become the property of the purchaser, he does not have any right to debit the asset at its full price. Hence, no entry is passed when the asset is purchased unless it involves down payment. The entries are passed as and when the instalments become due and the amount is paid towards the price of the article. The journal entries are as follows :
1. When the asset is purchased
No entry
2. When the down payments is made
Asset A/c Dr.
To Bank A/c
3. When the instalment becomes due
Asset A/c Dr. (cash price part of instalment)
Interest A/c Dr. (interest on instalment)
To Hire Vendor
4. When instalment is paid
Hire Vendor Dr.
To Bank A/c
5. When depreciation is charged
Depreciation A/c Dr.
To Asset A/c
6. When interest and depreciation accounts are closed by transfer to Profit & Loss A/c
Profit & Loss A/c Dr.
To Interest A/c
To Depreciation A/c
It should be noted that though the asset account is debited with the amount of the cash price paid (not full cash price), the depreciation is charged on the full cash price. The Balance Sheet will reflect the amount of cash price debited to the asset account minus depreciation charged.
