Hire Purchase System Explained with Journal Entries

Meaning of Hire Purchase Agreement

A Hire Purchase Agreement is a contract under which goods are given on hire, and the hirer has the option to purchase those goods by complying with the terms of the agreement. It generally includes the following conditions:

1. The possession of goods is transferred to the hirer by the owner (seller/creditor).
2. The hirer agrees to pay the hire purchase price in periodic instalments.
3. The ownership (property) of goods transfers to the hirer only when the last instalment is paid.
4. The hirer has the right to terminate the agreement at any time before the ownership is transferred.

Hire purchase is essentially a financing system where the buyer acquires goods by making payments in instalments.

Parties in Hire Purchase

1. Hire Purchaser (Buyer / Hirer)
2. Hire Vendor (Seller / Creditor)

The hire vendor transfers the asset’s possession but not the ownership. The buyer usually makes a down payment, and the remaining amount is paid in instalments. Although possession is given immediately after signing the agreement, the buyer becomes the owner only after paying all instalments.

Hire purchase is widely used as a method of financing the purchase of goods that will be fully owned in the future.

Nature of Hire Purchase Transaction

1. Goods are let out on hire by the seller or a finance company.
2. The hirer pays an agreed amount in instalments over a fixed period.
3. Ownership remains with the creditor until the final instalment is paid.
4. Once the last instalment is paid, ownership passes to the hirer.

Example - Sandeep purchases a bike from ABC Automobiles on a hire purchase basis:

• Cash Price of Bike = ₹80,000
• Down Payment = ₹20,000
• Amount financed through instalments = ₹60,000
• Instalment amount = ₹10,000 each
• Total amount paid = ₹90,000
• Additional ₹10,000 paid = Interest, due to delayed payment over instalments

Definition of Hire Purchase

According to the Hire Purchase Act, 1972, hire purchase is defined as: “An agreement under which goods are let on hire and under which the hirer has an option to purchase them in accordance with the terms of the agreement.”

It includes the following features:

1. Possession of goods is delivered by the owner to the hirer on the condition that the agreed amount is paid in periodic instalments.
2. Ownership of goods passes to the hirer only upon payment of the last instalment.
3. The hirer has the right to terminate the agreement before ownership is transferred.

Features of Hire Purchase System

1. Written Agreement - Hire purchase is always based on a written agreement between two parties the Hire Vendor (seller) and the Hire Purchaser (buyer).
2. Possession but Not Ownership - The buyer gets immediate possession of the goods at the time of entering into the contract, but ownership remains with the seller until all instalments are paid.
3. Payment in Instalments - The hire purchaser makes payment for the goods in periodic instalments, which include both principal and interest.
4. Option to Purchase - The agreement provides the buyer an option to purchase the goods after paying all instalments. Once the last instalment is paid, ownership is transferred to the buyer.
5. Right to Terminate - The hire purchaser has the right to terminate the agreement at any time before ownership passes. In such cases, the seller can repossess the goods.
6. Treatment of Instalments
• If the buyer completes all payments, each instalment is considered as part-payment of the cash price + interest.
• If the buyer stops paying, the instalments already paid are treated as hire charges, and the seller can take back the goods.
7. Repossession of Goods - If the hirer fails to pay instalments, the hire vendor has the right to repossess the goods, and the transaction remains a “hire” rather than a “purchase.”

Hire Purchase Agreement

The Hire Purchase (HP) Agreement - A Hire Purchase Agreement is a formal contract that must clearly state the following details:

1. Description of the motor vehicle or asset
2. Total amount payable under the agreement
3. Minimum deposit (down payment)
4. Term charges and the annual percentage rate (APR)
5. Late payment charges
6. Date on which hiring begins
7. Number of instalments
8. Amount of each instalment repayment
9. Name of the person/party to whom instalments are payable
10. Time and place of payment
11. Address where the vehicle or goods will be kept

Parties in a Hire Purchase Agreement

1. Seller (Dealer)
2. Financier (Finance Company)
3. Hirer (Customer/Buyer)

Process of Hire Purchase

1. Customer selects goods from the dealer
2. Dealer forwards details to the financier
3. Financier prepares the Hire Purchase Agreement
4. Customer makes the down payment to the dealer
5. Documents are sent to the finance company for approval
6. Finance company accepts the agreement
7. Hirer pays instalments over the agreed period
8. Ownership transfers to the hirer on payment of the last instalment

Essentials of a Hire Purchase Agreement

1. Delivery of goods must be given by the owner to the hire purchaser.
2. Payment is made in instalments at agreed intervals.
3. Ownership transfers to the hirer only after full payment of all instalments.
4. In case of default, the owner (seller/financier) may repossess the goods, and the instalments already paid are treated as hire charges (rent).

Rights Under a Hire Purchase Agreement

Rights of the Hirer

1. The hirer has the right to complete the purchase at any time by paying the full hire purchase price or the remaining balance.
2. The hirer may terminate the agreement at any time before ownership passes.
3. Upon termination, the hirer must return the goods to the owner.

Rights of the Owner

1. The owner has the right to terminate the hire purchase agreement if the hirer defaults on payments or misuses the goods.
2. Upon termination, the owner can retain the instalments already paid and recover any arrears due from the hirer.

Difference between Hire Purchase System and Credit Sale

Basis of Difference	Hire Purchase System	Credit Sale
1. Applicable Act	Governed by the Hire Purchase Act, 1972.	Governed by the Sale of Goods Act, 1930.
2. Nature of Contract	It is a contract of hire with an option to purchase.	It is a contract of sale.
3. Transfer of Ownership	Ownership is transferred only after payment of the last instalment.	Ownership is transferred immediately at the time of sale.
4. Right of Repossession	Seller can repossess the goods if the buyer defaults on instalments.	Seller cannot take back the goods; can only sue for recovery of price.
5. Mode of Payment	Price is always paid in instalments.	Payment is usually lump sum, but can be instalments if agreed.
6. Time of Payment	Payments may be monthly, quarterly, half-yearly, or yearly.	Payment schedule depends on the agreement between parties.

Journal Entries — Hire Purchaser

Date	Particulars	L.F.	Debit (₹)	Credit (₹)
1 April	Asset A/c Dr.		XXXX
	To Vendor’s A/c			XXXX
	(Being asset purchased on hire purchase; cash price)
1 April	Vendor’s A/c Dr.		XXXX
	To Cash A/c			XXXX
	(Being down payment made)
31 March	Interest A/c Dr.		XXXX
	To Vendor’s A/c			XXXX
	(Being interest due on outstanding amount)
31 March	Vendor’s A/c Dr.		XXXX
	To Cash A/c			XXXX
	(Being instalment paid)
31 March	Depreciation A/c Dr.		XXXX
	To Asset A/c			XXXX
	(Being depreciation charged)
31 March	Profit & Loss A/c Dr.		XXXX
	To Interest A/c			XXXX
	To Depreciation A/c			XXXX
	(Being interest and depreciation transferred to P&L)

Journal Entries — Hire Vendor

Date	Particulars	L.F.	Debit (₹)	Credit (₹)
1 April	Hire Purchaser’s A/c Dr.		XXXX
	To Hire Sales A/c			XXXX
	(Being cash price due from hire purchaser)
1 April	Cash A/c Dr.		XXXX
	To Hire Purchaser’s A/c			XXXX
	(Being down payment received)
31 March	Hire Purchaser’s A/c Dr.		XXXX
	To Interest A/c			XXXX
	(Being interest due from hire purchaser)
31 March	Cash A/c Dr.		XXXX
	To Hire Purchaser’s A/c			XXXX
	(Being instalment received)
31 March	Interest A/c Dr.		XXXX
	To Profit & Loss A/c			XXXX
	(Being interest transferred to P&L)
31 March	Hire Sales A/c Dr.		XXXX
	To Trading A/c			XXXX
	(Being hire sales transferred to Trading A/c)

Illustration (When interest is included in instalments) 

On 1st April, 2011, Gopal purchased a Machinery from Delhi Transport Ltd. on hire purchase system. The cash price of the machinery was ₹ 34,870 and the payment was made as under:

• ₹ 10,000 on delivery, and
• three further instalments of ₹ 10,000 each at the end of each year.

Vendor charges interest @ 10% p.a., Gopal provides depreciation @ 20% p.a. on diminishing balance method. Pass journal entries and prepare necessary accounts in the books of both parties. Accounts are closed on 31st March every year.

Solution

Calculation of Interest

Instalment	Opening balance on which interest charged	Interest @10%	Principal (instalment − interest)
On delivery (immediate)	—	—	₹ 10,000 (down payment)
1st instalment (31-03-2012)	₹ 24,870	₹ 2,487	₹ 7,513
2nd instalment (31-03-2013)	₹ 17,357	₹ 1,736	₹ 8,264
3rd instalment (31-03-2014)	₹ 9,093	₹ 907	₹ 9,093
Totals		₹ 5,130	₹ 34,870 (cash price repaid)

Total cash paid by Gopal = Down payment ₹10,000 + 3 instalments ₹30,000 = ₹40,000 (includes interest ₹5,130).

Journal Entries — In the books of Gopal (Hire-Purchaser)

01-04-2011

Machinery A/c Dr. ₹34,870

  To Delhi Transport Ltd. (Vendor) A/c ₹34,870

(Being machinery purchased under hire-purchase at cash price)

01-04-2011

Delhi Transport Ltd. A/c Dr. ₹10,000

  To Cash A/c ₹10,000

(Being down payment on delivery)

31-03-2012

Interest A/c Dr. ₹2,487

  To Delhi Transport Ltd. A/c ₹2,487

(Being interest due on outstanding ₹24,870 @10%)

31-03-2012

Delhi Transport Ltd. A/c Dr. ₹10,000

  To Cash A/c ₹10,000

(Being payment of 1st instalment)

31-03-2012

Depreciation A/c Dr. ₹6,974

  To Machinery A/c ₹6,974

(Being depreciation @20% on cash price ₹34,870)

31-03-2012

Profit & Loss A/c Dr. ₹9,461

  To Interest A/c ₹2,487

  To Depreciation A/c ₹6,974

(Being transfer of interest and depreciation to P&L)

31-03-2013

Interest A/c Dr. ₹1,736

  To Delhi Transport Ltd. A/c ₹1,736

(Being interest due on outstanding ₹17,357 @10%)

31-03-2013

Delhi Transport Ltd. A/c Dr. ₹10,000

  To Cash A/c ₹10,000

(Being payment of 2nd instalment)

31-03-2013

Depreciation A/c Dr. ₹5,579

  To Machinery A/c ₹5,579

(Being depreciation @20% on NBV ₹27,896 — i.e., 34,870 − 6,974)

31-03-2013

Profit & Loss A/c Dr. ₹7,315

  To Interest A/c ₹1,736

  To Depreciation A/c ₹5,579

(Being transfer of interest and depreciation to P&L)

31-03-2014

Interest A/c Dr. ₹907

  To Delhi Transport Ltd. A/c ₹907

(Being interest due on outstanding ₹9,093 @10% — rounded)

31-03-2014

Delhi Transport Ltd. A/c Dr. ₹10,000

  To Cash A/c ₹10,000

(Being payment of 3rd instalment)

31-03-2014

Depreciation A/c Dr. ₹4,463

  To Machinery A/c ₹4,463

(Being depreciation @20% on NBV ₹22,317)

31-03-2014

Profit & Loss A/c Dr. ₹5,370

  To Interest A/c ₹907

  To Depreciation A/c ₹4,463

(Being transfer of interest and depreciation to P&L)

Journal Entries in the Books of Delhi Transport Ltd. (Vendor)

01-04-2011

Gopal A/c…………Dr. 34,870

 To Hire Sales A/c…………34,870

(Being machinery sold on hire-purchase at cash price)

01-04-2011

Cash A/c…………Dr. 10,000

 To Gopal A/c…………10,000

(Being down payment received on delivery)

31-03-2012

Gopal A/c…………Dr. 2,487

 To Interest A/c…………2,487

(Being interest due on outstanding balance)

31-03-2012

Cash A/c…………Dr. 10,000

 To Gopal A/c…………10,000

(Being first instalment received)

31-03-2012

Hire Sales A/c…………Dr. 34,870

 To Trading A/c…………34,870

(Being hire-sales transferred to Trading A/c)

31-03-2012

Interest A/c…………Dr. 2,487

 To Profit & Loss A/c…………2,487

(Being interest transferred to Profit & Loss Statement)

31-03-2013

Gopal A/c…………Dr. 1,736

 To Interest A/c…………1,736

(Being interest due for the year)

31-03-2013

Cash A/c…………Dr. 10,000

 To Gopal A/c…………10,000

(Being second instalment received)

31-03-2013

Interest A/c…………Dr. 1,736

 To Profit & Loss A/c…………1,736

(Being interest transferred to Profit & Loss Statement)

31-03-2014

Gopal A/c…………Dr. 907

 To Interest A/c…………907

(Being interest due for the year)

31-03-2014

Cash A/c…………Dr. 10,000

 To Gopal A/c…………10,000

(Being third and final instalment received)

31-03-2014

Interest A/c…………Dr. 907

 To Profit & Loss A/c…………907

(Being interest transferred to Profit & Loss Statement)

Ledger— In vendor’s books

Hire Sales A/c

• Dr. 01-04-2011 To Gopal ₹34,870
• Cr. 31-03-2012 By Trading A/c ₹34,870

Gopal A/c (Debtor in vendor’s books)

Dr: Interest charges (₹2,487; ₹1,736; ₹907) increase balance; Cr: cash receipts (₹10,000 each) reduce balance. Final balance becomes nil after last instalment.

Interest A/c

Cr: Interest credited from Gopal (₹2,487; ₹1,736; ₹907) — then debited/transferred to P&L each year.

Closing notes / checks

1. Total principal recovered by vendor = ₹34,870 (cash price).
2. Total interest earned by vendor = ₹5,130 (2,487 + 1,736 + 907).
3. Total cash receipts from Gopal = ₹40,000 (down payment + three instalments).
4. Depreciation in purchaser’s books is charged on the cash price (as you used) and posted to P&L.

Related Posts

Previous

Next