Thursday, July 12, 2012

Hire Purchase and Installment Purchase System

Unit – 2: Hire Purchase and Installment Purchase System
Hire Purchase - Meaning:
A trader could sell goods either for cash or for credit. For goods sold on credit, the payments may be made by the buyer in lump sum on a future date, or in installments spread over for a specified period of time. When goods are sold on credit, for which payment is made by the buyer in installments over a period of time, it is called purchase system or installment system.
Hire Purchase System defers to the system wherein, the seller of goods transfer the goods to the buyer without transferring the ownership of goods. The payment for the goods will be made by the buyer in installments. If the buyer pays all the installments, the ownership of the goods will be transferred, on payment of the last installment. However, if the buyer does not pay for any installment, the goods will be repossessed by the seller and the money paid on earlier installments will be treated as hire charges for using the goods. So, under this system, the transaction may result in purchasing of goods by the buyer or in hiring the goods. Hence, the system is called Hire Purchase System.
Characteristics of Hire-Purchase System
The characteristics of hire-purchase system are as under
a)      Hire-purchase is a system of credit sale.
b)      The price under hire-purchase system is paid in installments.
c)       The goods are delivered in the possession of the purchaser at the time of commencement of the agreement.
d)      Hire vendor continues to be the owner of the goods till the payment of last installment.

e)      The hire-purchaser has a right to use the goods as a bailer.
f)       The hire-purchaser has a right to terminate the agreement at any time in the capacity of a hirer.
g)      The hire-purchaser becomes the owner of the goods after the payment of all installments as per the agreement.
h)      If there is a default in the payment of any installment, the hire vendor will take away the goods from the possession of the purchaser without refunding him any amount.
Advantages: Following are the advantages of hire purchase:
(i)      Costly items can easily be purchased by the consumers which he cannot otherwise purchase by making entire payment in lump sum.
(ii)    It increase turnover and enhances the profitability of the enterprise. This is reflected in a general reduction in profit-margins in the competitive atmosphere of retail trade, so that the general public benefits by lower prices, whether or not they buy hire purchase.
(iii)   It enables the consumer's family to enjoy the possession of the goods before payment is required. By arranging repayments over a period of time the consumer budget for the purchase of expensive capital times out of weekly or monthly earnings.
(iv)  Hirer has a right to terminate the agreement at any time before the goods is transferred.
(v)    Hire purchase is a rewarding field of financial investment today, because, despite the chance of bad debts, the rewards earned are higher than the normal rates of interest.
Disadvantages: Following are the disadvantages of hire purchase:
(i)      Cost of items purchased by hire purchase system is more than the normal price as the customer has to pay interest on the balance amount.
(ii)    Hirer does not become the owner of goods hired, until payment of last installment is made.
(iii)   Hirer cannot sell or pledge goods hired until he becomes owner of such goods.

Difference between Sale and Hire Purchase
Although hire purchase system could ultimately result in sale of goods, the sale in normal sense and sale under hire purchase system are not the same. The following are the differences between sale and hire purchase.
Sale
Hire Purchase
A ‘sale’ is governed by the sale of Goods Act, 1930.
Hire purchase is governed by the Hire Purchase Act, 1972.
In case of sale, the ownership of the goods is transferred to the buyer immediately.
In case of Hire purchase, the ownership of goods is transferred to buyer on payment of all installments.
In case of sale, the buyer makes payment in lump sum.
In case of hire purchase, the payment is made in installments.
The buyer pays only for the price of goods.
The hire purchaser pays for the price of goods and also some amount of interest.
On non-payment of the consideration the seller cannot take back the goods, but can only take legal action on buyer.
On non-payment of any installment, the seller can re-possess the goods.
Once a sale has taken place, neither the seller, nor the buyer can terminate the contract (unless it is for genuine reason like damage of goods etc.)
Either the buyer or the seller can terminate the contract at any point of time, until the payments of last installment.
When the buyer becomes insolvent, the seller has to undertake the risk of loss.
When the hire purchaser becomes insolvent, the seller can reposes the goods, and hence need not undertake the risk of loss.
A sale is subject to levy of sales tax at the time of contract of sale.
In this case, the sales tax will be leviable at the time of ownership (i.e. on payment of last installment).
Difference between Agreement to Sale and Hire Purchase
Although hire purchase system could ultimately result in sale of goods, the agreement to sale in normal sense and sale under hire purchase system are not the same. The following are the differences between sale and hire purchase.
Agreement to Sale
Hire Purchase
A ‘sale’ is governed by the sale of Goods Act, 1930.
Hire purchase is governed by the Hire Purchase Act, 1972.
Contract of Sale includes both sale and agreement to sale.
Hire purchase is bailment plus agreement to Sale.
Agreement to sale is a step, to the contract of sale.
Hire purchase agreement becomes a sale only after full payment.
In an agreement to sale, the buyer can sell or pledge the goods.
In Hire purchase, the buyer cannot sell or pledge the goods.
The buyer pays only for the price of goods.
The hire purchaser pays for the price of goods and also some amount of interest.

Rights and Obligations of the Hirer and Owner
a)      Right of hirer to purchase at any time with rebate: The hirer may, at may time during the continuance of the hire-purchase agreement and after giving the owner not less than fourteen days notice in writing of his intention so to do, complete the purchase of the goods by paying or tendering to the owner the hire-purchase price or the balance thereof as reduced by the rebate.
b)      Right of hirer to terminate agreement at any time: The hirer may, at Dairy time before the final payment under the hire-purchase agreement falls due, and after giving the owner not less than fourteen days’ notice in writing of his intention so to do, terminate the hire-purchase agreement.
c)       Right to appropriate payments in respect of two or more agreements in such proportions as he thinks fit.
d)      Assignment and transmission of hirer’s rights or interest under hire-purchase agreement: The hirer may assign his right, title and interest under the hire-purchase agreement with the consent of the owner, or, if his consent is unreasonably withheld, without his consent.


e)      Rights of hirer in case of seizure of goods by owner: Where the owner seizes the goods let under a hire-purchase agreement, the hirer may recover from the owner the amount, if any, by which the hire-purchase price falls short of the aggregate of the following amounts, namely the date
(i)      The amounts paid in respect of the hire-purchase price up to the date of seizure;
(ii)    The value of the goods on the date of seizure.
OBLIGATIONS OF THE HIRER
a)      Obligation of hirer to comply with agreement: Subject to the provisions of this Act, a hirer shall be bound:
(i)      To pay the hire in accordance with agreement, and
(ii)    Otherwise to comply with the terms of the agreement.
b)      Obligation of hirer in respect of care to be taken of goods: A hirer in the absence of a contract to the contrary shall be bound to take as much care of the goods to which the hire-purchase agreement relates as a man of ordinary prudence would, under similar circumstances, take of his own goods of the same bulk, quality and value. The hirer shall be liable to in make compensation to the owner for any damage caused by failure to take care of the goods.
c)       Obligation of hirer in respect of use of goods: If he hirer makes any use of the goods to which the hire-purchase agreement relates which is not according to the conditions of the agreement, the hirer shall be liable to make compensation to the owner for any damage arising to the goods from or during such use.
d)      Obligation of the hirer to give information is to where about of goods: Where by virtue of a hire-purchase agreement a hirer is under a duty to keep in his possession or control the goods to which the agreement relates, the hirer shall, on receipt of a request in writing from the owner, inform the owner where the goods are at the time when the information if given or, if it is sent by post, at the time of posting.
(i)      Rights of owner to terminate hire-purchase agreement for default in payment of hire or authorised act or breach of express conditions: Where a hirer makes more than one default in the payment of hire-purchase agreement then, subject to the provisions of Section 21 and after giving the hirer notice in writing of not less than-
a.       One week, in a case where the hire is payable at weekly or lesser intervals; and
b.      Two weeks, in any other case,
The owner shall be entitled to terminate the agreement by giving the hirer notice of termination in writing:
(ii)    Rights of owner on termination: Where a hire-purchase agreement is terminated under this Act, then the owner shall be entitled to retain the hire which has already been paid and to recover the arrears of’ hire due.
OBLIGATIONS OF THE OWNER
Obligation of owner to supply copies and information: It shall be the duty of the owner to supply, free of cost, a true copy of the hire-purchase agreement, signed by the owner, -
(a)  To the hirer, immediately after execution of the agreement; and
(b)  Where there is a contract of guarantee, to the surety, on demand made at any time before the final payment has been made under the agreement.
It shall also be the duty of the owner, at any time before the final payment has been made under the hire-purchase agreement, to supply to the hirer, within fourteen days after the owner receives a request in writing from the hirer in this behalf and the hirer tenders to the owner the sum of one rupee for expenses, statement signed by the owner or his agent showing-
(a)    The amount paid by or on behalf of the hirer;
(b)   The amount which has become due under the agreement but remains unpaid, and the date upon, which each unpaid installments became due, and the amount of each such installments; and
(c)    The amount which is to become payable under the agreement, and the date or the mode of determining the date upon which each future installments is to become payable, and the amount of each such installments.
Accounting treatment in the books of hire purchaser
There are three methods to maintain the accounts in the books of hire purchaser they are.
A. Outright property method: under this method the asset is recorded at full cash price.
B. Asset accrual method: under this method the asset is recorded at the cash price actually paid (asset accrued is recorded)
C. Interest suspense method: under this method the total interest is first debited to interest suspense account at the beginning subsequently the interest due at the end of the period is credited to interest suspense account.
JOURNAL ENTRIES IN THE BOOKS OF HIRE-PURCHASER
Sl.No.
Circumstances
Outright property
Asset accrual
Interest suspense
At the time of asset purchased.
01
When the asset is purchased
Asset a/c Dr
  To hire vendor a/c
No entry
Asset a/c Dr
Interest suspense a/c Dr
  To vendor a/c
02
When the down payment is made
Hire vendor a/c Dr 
  To bank a/c
Asset a/c Dr
  To bank a/c
Vendors a/c Dr
  To bank a/c
 At the end of every year.
03
When the installment interest becomes due
Interest a/c Dr
To hire vendor a/c
Asset a/c Dr
Interest a/c Dr
  To hire vendor a/c
Interest a/c Dr
  To interest suspense a/c
04
When the installment is paid
Hire vendor a/c Dr 
To bank a/c
Hire vendor a/c Dr 
To bank a/c
Vendors a/c Dr
  To bank a/c
05
When the depreciation is charged
Depreciation a/c Dr
  To asset a/c
Depreciation a/c Dr
  To asset a/c
Depreciation a/c Dr
  To asset a/c
06
When the depreciation and interest is transferred to p/l a/c
Profit / loss a/c Dr
  To interest a/c 
  To depreciation a/c
Profit / loss a/c Dr
  To interest a/c 
  To depreciation a/c
Profit / loss a/c Dr
  To interest a/c 
  To depreciation a/c


JOURNAL ENTRIES IN THE BOOKS OF HIRE-VENDOR 
Sl. No.
Circumstances
Outright property
Asset accrual
Interest suspense
          At the time of asset purchased.
01
When the asset is sold
 Hire-purchaser a/c Dr 
  To sales a/c 
No entry
 Purchaser a/c Dr
  To sales a/c
  To interest suspense a/c
02
When the down payment is received 
  Bank a/c Dr
  To hire-purchaser a/c  
Asset a/c Dr
  To bank a/c
Bank a/c Dr
  To purchaser a/c    
          At the end of every year.
03
When the installment interest becomes due
Hire-purchaser a/c Dr
  To Interest a/c 
Asset a/c Dr
Interest a/c Dr
  To hire vendor a/c
interest suspense a/c Dr
  To Interest a/c
04
When the installment is received
 Bank a/c Dr
  To hire-purchaser a/c  
Hire vendor a/c Dr
To bank a/c
 Bank a/c Dr
  To purchaser a/c 
05
When the interest is transferred to p/l a/c
Interest a/c  Dr
  To Profit / loss a/c  
Profit / loss a/c Dr 
  To interest a/c 
  To depn a/c 
Interest a/c  Dr
  To Profit / loss a/c   
Ascertainment of interest:
1. When rate of interest is given: - Cash price less down payment add interest less installment 
2. When rate of interest is not given: - Ascertain total amount of interest (total amount- cash price) and then ascertain the interest installment with the help of ratio of amount due at the beginning of each year.
Amount due at the beginning of 1st year = total amount- down payment
Amount due at the beginning of 2nd year = first year due – 1st installment
Amount due at the beginning of 3rd year = second year due – 2nd installment
Ascertainment of total cash price:
1. Without the help of annuity table  
2. with the help of annuity table 
1. without the help of annuity table: - Total cash price = cash price installment + down payment
Cash price installment is calculated by deducting the interest installment from the installment amount starting with last installment. The interest installment is calculated with the help of following formula:


Interest= total amount due at the time of installment X   (rate of interest /100+rate of interest)    
2. with the help of annuity table: - under this method the cash price is ascertained with the help of annuity value.
Cash price installment = installment X annuity value
Total cash price = cash price installment + down payment  
Important terms and provisions in Hire Purchase Agreement
1. Hire purchaser: A hire purchaser is a person who possesses the goods under hire purchase agreement for use within an option to either purchase it or return after use.
2. Hire vendor: a hire vendor is a person who sells the goods under hire purchase agreement.
3. Cash price: it is the price of goods which is sold under ‘contract of sale’
4. Hire purchase price: it is the price at which the goods are sold under ‘hire purchase system’ it includes cash price of the goods and interest.
5. Installment money: it is the part of the hire purchase price paid by hire purchaser, in periodic intervals.
6. Deposit: it refers any sum payable by the hirer under the hire purchase agreement by way of initial payment or credited or to be credited to him under the agreement on account of any deposit.
7. Net cash price: it refers to the difference between cash price of the goods and deposit (cash price-down payment=net cash price).
8. Net hire purchase price: it is the net amount after deducting the delivery charges, registration charges, insurance charges from hire purchase price.
9. Hire charges: it is an amount refers to the difference between hire purchase price and cash price (H P- C P= H C) it also referred to as interest.
10. Statutory hire charges: it is a hire charges according to the hire purchase act of, 1972.
11. Hire purchase agreement: it is an agreement between hire purchaser and hire vendor according to section 2(c) of the hire purchase act, 1972 for purchasing of goods according to agreement.
12. Rebate: it is an amount which is claimed by the hire purchaser from the hire vendor in case if he decides to remit the balance of the purchase price (future installments) in lump sum without continuing the hire purchasing agreement.
The rebate is calculated as follows
Rebate = 2/3 X hire charges X (no. of installments due/total no. of installments)
13. Termination of hire purchase agreement: The hirer can terminate the agreement at any time by giving the 14 days notice to the owner. However whatever the amount is already paid by the hirer is considered as a hire charges.
INSTALMENT PURCHASE SYSTEM
Meaning: Installment payment system (also called the deferred installments) is a system where the buyer is given the ownership as well as the possession of the gods at the time of signing the contract. The buyer has the facility to pay the price in installments.
Definition: According to J.B. Batliboi, Installment Purchase System is a system under there is an agreement to purchase and pay by installments, the goods which become the property of the Purchaser immediately when he receives the delivery of the same.
Features of Installment Payment System:
The features of Installment payment are as follows:
a)      Under this system, there will be an outright sale of goods/assets.
b)      The possession as well as the ownership is passed to the buyer right at the time of signing the contract.
c)       The buyer can make the payment in installments.
d)      IN case of default in payment, the seller cannot repossess the goods, but he can sue the buyer for the recovery of unpaid price.
e)      The buyer cannot exercise the option of returning the goods and terminate the contract, unless the same becomes void or voidable under the contract act.
Differences Between Hire Purchase System and Installment Purchase System:
Hire-Purchase System
Installment Purchase
It is a contract of hiring.
It is a contract of sale.
It is transferred by seller to buyer only after payment of all installments.
It is transferred by seller to buyer, immediately on signing the contract.
In this case, the buyer is like a bailee
In this case, the buyer is not in the position of a bailee
Such risk is on the seller.
Such risk is on the buyer.
On default of payment of any installment by the buyer, the seller can repossess the goods.
On default and payment of any installment by the buyer, seller cannot repossess the goods, but can file a suit in the court of law against the buyer for the recovery of unpaid price.
The buyer can exercise the option of return of goods.
The buyer cannot exercise the option of return of goods.
The buyer cannot dispose the goods, until the payment of last installment. If disposed, the third party buyer does not get a better title.
The buyer has the right to dispose the goods, even if all installments are not yet paid.
Default and re-possession
When hire purchaser is not able to make the payment in time, then default is committed by him and the owner takes back the possession of goods. There are two possibilities:
1) When seller takes back the possession of complete goods called complete repossession.
2) When seller takes possession of only part of the total assets sold called partial repossession.
Complete Repossession: When the vendor takes back the possession of complete goods from the vendee in case of default in payment of installment, such process is called complete repossession of goods. In such case, the vendor closes the books of account of the hire-purchaser by transferring the balance to the goods repossessed account. Similarly, the hire-purchaser also closes the account of hire-vendor account by transferring the balance to assets account.
In the case accounting treatment is as follows: In the books of purchaser:
1) All entries are passed as usual up to the date of default.
2) Buyer closes the account of seller by passing the entry:
Hire vendor account Dr
To assets account
3) Any balance left in asset account is closed by transferring to P & L account.
In the books of seller
1) All entries are passed as usual up to the date of default.
2) Seller closes the purchaser account by passing:
Re possessed goods account                      Dr.
To hire purchaser
3) Re possessed goods account or goods returned account is debited with all expenses incurred and re sale price is credited and if any balance, it is transferred to P & L account.
Partial Repossession: When the vendor takes possession of only part of the total goods sold from the vendee, such process is called partial repossession. In case of partial repossession of goods, Vendor’s Account is debited and the Asset Account is credited with the agreed value of goods repossessed. Since, the entire goods are not repossessed, Asset Account will have a balance for the goods not repossessed which will be equal to the depreciated value of the assets not repossessed and, naturally, Vendor’s Account will show a balance which will represent the amount due to the purchaser. If the agreed value of goods repossessed is not given, the same may be ascertained after charging depreciation from the original cost of the asset, i.e., written-down value at the date of repossession.
In the case accounting entries are similar to those of complete repossession. The additional precautions to be taken are:
1) Both the buyer and seller do not closes seller’s account and buyer’s account in their respective books. The entry for repossession is passed with the agreed value of assets taken by the vendor.
2) The buyer finds out the value of asset still left with him using the normal rate of depreciation. This account shows the balance of asset, which is left, to him.
3) After crediting the asset account with the value of asset taken away by the seller and after keeping the balance of asset left, the difference by the asset account is transferred to P&L account.

Labels

Absorption Costing (1) Accountancy (4) accounting for partnership firms (3) Accounting for Share Capital (3) accounts of non trading concern (3) advanced financial accounting (14) AHSEC (108) ahsec 11 (47) ahsec 12 (60) ahsec notes (104) AHSEC Question Papers (33) Assam Slet (10) bcfm (11) bills of exchange (6) branch accounting (3) Budgetary Control (3) Budgetary Control Notes (2) business communication (28) Business Environment Notes (12) business regulatory framewrok (49) Business Statistics Notes (25) cash flow statement (5) cbse 12 (19) cbse notes (27) commerce (13) company law (23) corporate accounting (33) corporate laws (14) cost accounting (63) cost and management accounting (34) cpt (36) cpt 200 (7) cpt notes (30) dibrugarh university (1113) dibrugarh university notes (597) dibrugarh university question paper (454) dibrugarh university solved papers (225) dibrugarh university syllabus (47) direct tax law (49) eco - 01 (4) ECO - 02 (2) ECO - 03 (2) ECO - 05 (6) ECO - 06 (1) ECO - 07 (1) eco - 08 (4) eco - 09 (1) ECO - 10 (2) ECO - 11 (3) ECO - 12 (7) ECO - 13 (2) ECO - 14 (4) entrepreneurship (14) fianancial accounting (3) financial accounting (48) Financial Accounting Notes (15) financial management (18) Financial statements analysis (14) funds flow statement (3) guwahati university (289) guwahati university syllabus (52) Hire Purchase (5) Human Resource Management (11) icwai (38) icwai notes (39) ignou solved assignments (83) ignou solved question papers (121) income from house property (5) income from salary (4) Income Under the head Salaries (11) information technology (10) Installment Purchase (4) issue of shares (4) kkhsou (13) M.com (62) Management Accounting Notes (31) MCQ (11) paper I (1) paper II (9) paper III (1) principle of business mangement (16) Principles of Marketing Notes (16) royalty accounts (3) sale of goods act (8) semester I (151) Semester II (154) semester III (81) semester IV (149) semester V (111) semester VI (91) slet (13) Slet Ne (10) Small Business Management (7) solved assignments (22) UGC - NET: Commerce (08) (14) UGC - NET: Commerce (08) Paper II (3) UGC - NET: Commerce (08) Paper III (14) ugcnet solved question papers (23) Variance Analysis Notes (1)